International Paper Company (NYSE:IP) Q4 2023 Earnings Call Transcript

International Paper Company (NYSE:IP) Q4 2023 Earnings Call Transcript February 1, 2024

International Paper Company beats earnings expectations. Reported EPS is $0.41, expectations were $0.34. IP  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and thank you for standing by. Welcome to today’s International Paper’s Fourth Quarter 2023 Earnings Call. [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, Greg. Good morning, and thank you for joining International Paper’s Fourth Quarter 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 fourth quarter earnings press release and today’s presentation slides. With that, I’ll now turn it over to Mark Sutton.

Mark Sutton: Thank you, Mark, and good morning, everyone. We will begin our discussion on Slide 3, where I will touch on our full year 2023 results. As I reflect on this past year, I’m very appreciative of all the hard work our employees have performed and for our strong customer relationships as we managed through a challenging market environment. Our teams across International Paper executed well, both commercially and operationally. They work closely with our customers to create value and serve their needs, while navigating an uncertain and changing demand environment. Our teams were also focused on driving our cost in all categories of spend across our large network of mills, box plants and supply chain operations. In addition, we took strategic actions to structurally reduce fixed costs in our mill system, in our Industrial Packaging business and our Global Cellulose Fibers business.

We also made significant progress in Building a Better IP, by delivering $260 million of earnings benefits in 2023, driven by commercial and process improvement initiatives. I’m pleased to say that we’ve exceeded our target each year since we began this initiative, which demonstrates how Building a Better IP is now a mindset embedded in our culture, with intense focus on maximizing value through commercial and operational excellence. We also advanced our strategies to improve profitability across our portfolio. In our box business, our go-to-market strategy is focused on improving margins and mix by investing in capabilities to enhance our value proposition to align with customer needs. In Global Cellulose Fibers, our strategy is focused on optimizing the business, by reducing exposure to commodity pulp and aligning our mill footprint.

We will be sharing more about these strategies later in the presentation. And in addition to reinvesting in our businesses, we also preserved our solid balance sheet and returned approximately $840 million to our shareholders. As we go through the rest of the presentation, we’ll share our perspective on the market and the trends across our portfolio. We thought this would be helpful as you reflect on industry dynamics entering the new year. I will now turn it over to Tim who will provide more details. Tim?

Timothy Nicholls: Great. Thank you, Mark. Good morning, everyone. If we turn to Slide 4, the full year key financials. As Mark mentioned earlier, 2023 proved to be a challenging market environment, which impacted our financial performance. During much of the year, underlying demand for our products was lower, as consumers prioritize spending on services and essential goods. This trend was influenced by the pull forward of goods during the pandemic, as well as by inflationary pressures and rising interest rates that impacted the consumer. Demand for our products was further constrained by inventory destocking, as our customers and the broader supply chain work through elevated inventories of their products. The lower demand, combined with declining sales prices for our products and sticky cost inflation resulted in lower revenues and earnings in 2023, when compared to prior periods.

Based on shipment trends across the markets we serve, we saw a demand trough in the first half of 2023, and then continued to see improvement throughout the year. In addition, we benefited from the Building a Better IP initiatives Mark just mentioned. And as a reminder, free cash flow for the year included a onetime use of cash totaling approximately $200 million, related to our timber monetization actions. Now I’ll turn to the fourth quarter key financials on Slide 5. Operating earnings per share came in better than the outlook we provided in the third quarter. Our teams executed well, by optimizing costs and delivering commercial initiatives focused on margin and mix improvement. And as we announced in the third quarter, we closed our containerboard mill in Orange, Texas, and permanently idled 2 pulp machines in our mills in Riegelwood, North Carolina, and Pensacola, Florida.

We expect the cost benefits from these closures to ramp throughout 2024. We are also encouraged to see that demand continue to recover across our portfolio in the fourth quarter, and we expect this trend to continue going forward. Now turning to Slide 6, I’ll provide more details about the quarter as we walk through the sequential earnings bridge. Fourth quarter operating earnings per share was $0.41 as compared to $0.64 in the third quarter. Price and mix was lower by $0.18 per share, primarily due to index movements across our portfolio and lower export sales price. This was partially offset by margin and mix benefits from commercial initiatives in both businesses. Volume was favorable to earnings by $0.07 per share, as higher demand across our portfolio more than offset one less shipping day in our North American packaging business.

We also had lower shipments of commodity pulp as we executed our strategy focused on improving mix and optimizing that business. Operations and cost was unfavorable by $0.12 per share sequentially. This is due to a nonrepeat of a favorable onetime item we called out in the third quarter related to lower cost of company paid benefits, totaling about $80 million or $0.18 per share. This nonrepeat was partially offset by our continued focus on reducing marginal cost and spending. We’re accomplishing this by optimizing fiber and energy costs, reducing flavor overtime and corporate overhead expenses, driving down supply chain costs and shifting to lower-cost suppliers. We also had lower unabsorbed fixed costs related to less economic downtime as demand improved across our portfolio.

Maintenance outages were higher by $13 million or $0.03 per share in the fourth quarter, and input costs were lower overall as increased pricing for OCC was offset by lower cost for energy, chemicals and wood. And finally, corporate items were impacted by a higher effective tax rate in the fourth quarter. offsetting lower corporate expenses. Turning to the segments and starting with Industrial Packaging on Slide 7. Price and mix was lower due to index movements, lower export prices and higher export mix as demand improved. This was partially offset by benefits from commercial initiatives focused on margin improvement in our box business. Later in this presentation, Mark will talk more about this go-to-market strategy. Volume was higher despite one less shipping day in box.

We saw sequentially higher daily shipments in our box business and higher volumes across our domestic and export containerboard channels. Operations and cost was unfavorable sequentially due to the nonrepeat items that I mentioned earlier, which benefited the third quarter in this business by $68 million. The majority of this was offset by lower economic downtime in the quarter as demand improved, and reflects the intense focus by our teams to reduce costs across our mills and box plants. Planned maintenance outages were lower by $22 million sequentially due to a seasonally lower outage schedule and our efforts to optimize outage spending across the mill system. Input costs were moderately lower primarily due to lower cost for energy and chemicals, partly offset by higher OCC costs.

Turning to Slide 8. We thought it would be helpful to share some additional perspective on segment trends for our North American packaging business, based on feedback from our customers. As shown on the previous slide, our U.S. box shipments in the fourth quarter were up approximately 3% sequentially, and we’ve continued to see demand growth in packaging since the trough in the March of 2023. E-commerce has been very resilient, with our shipments in 2023, up approximately 30% since 2019. This continues to be an attractive channel for our consumers as evidenced during the past holiday season. International Paper has strategic customer relationships and a strong value proposition, with scale and geographic reach to support seasonal demand surges.

Shipping and distribution was significantly affected by inventory destocking efforts across its longer supply chains. As a result, we’ve seen improvement across the segment since the destocking phase ran its course. Food and beverage has been relatively stable overall. The Fresh fruit — fresh foods segment has benefited from solid performance across the food service channel and consumer shifts toward making home meals in place of processed food and its convenience. The protein segment has been impacted by supply reductions in beef and poultry. International Paper is overweight in this segment, which has impacted our box shipment performance relative to the overall industry. We believe this is temporary and expect trends to improve in 2024.

The Beverage segment has been under pressure as budget-conscious consumers have reduced consumption of specialty beverages, which tend to be more packaging-intensive. On the other side of the spectrum, segments like durables and other nondurable consumer goods are more discretionary in nature and have been under pressure. Based on customer feedback and economic data like housing starts and consumer expectations, we expect demand in this packaging-intensive segment to improve. In summary, based on these trends, we believe industry box demand will grow approximately 3% in 2024. We understand the critical role corrugated packaging plays and bringing essential products to consumers, and we believe that IP is well positioned to grow with our customers over the long term.

Turning to Slide 9. I’ll touch on what we’re seeing across our containerboard export channel. Demand for kraft containerboard continued to improve through the fourth quarter and based on feedback from our customers, inventories appear to have normalized across all regions. In terms of segment performance, we are seeing solid demand in fresh fruit and vegetable markets, where we have a strategic customer relationship in Latin America and the Mediterranean. Demand across the industrial segments in Europe and Asia remained soft due to the lower consumer demand for durables and nondurable products. We expect these segments to recover as the broader economy improves, and International Paper is well positioned to grow with these segments due to their performance requirements and need for heavyweight kraft linerboard.

Moving on to Global Cellulose Fibers on Slide 10. We’ll take a look at the fourth quarter. Price and mix was lower due to price index movements, partially offset by benefits from higher fluff and specialty pulp mix. Volume was relatively flat overall, as higher demand for fluff and specialty pulp was offset by lower sales of commodity grades as we continue to focus on strategically aligning our business with the most attractive customers and segments. Operations and cost was unfavorable sequentially due to the nonrepeat item I mentioned earlier, which benefited the third quarter in this business by $12 million. In addition, ops and costs included a planned turbine maintenance expense of $18 million. Planned maintenance outages were also higher in the fourth quarter by $35 million.

And finally, input costs were lower by $7 million, primarily due to lower wood and chemical costs. Turning to Slide 11. I’ll talk about what we’re seeing across the fluff pulp segment. Overall demand has continued to improve through the fourth quarter, and we expect this trend to continue this year. Inventories have normalized across much of our customer base. We are seeing most of the improvement to date from the developed economies driven by improving consumer demand, stabilizing inflation and more stable currencies. Demand in China and the Middle East has been stable, and we expect a normal seasonal decline in those regions in the first quarter due to Chinese New Year and Ramadan. Inventories are elevated, however, we expect them to normalize in the second quarter.

On Slide 12, I’ll share a few comments about 2024. Given the fluid market environment, we have chosen not to provide a full year earnings outlook. However, we will share our view of demand trends and IP improvement initiatives as well as other financial assumptions. Overall, we believe the demand environment will continue to improve across our portfolio, and we have initiatives focused on improving mix and margins in both businesses. We expect the first quarter of 2024 will be an earnings trough due to seasonally low volumes, seasonally higher costs and unfavorable impacts from the January winter freeze. Also, the majority of prior publication declines will flow through the first quarter. Regarding demand trends, we expect packaging and fluff pulp markets to grow approximately 3% year-over-year.

In 2024, our North American box business may trail the market as we continue to execute a go-to-market strategy focused on margin and mix improvement. Given International Paper’s commercial and operational initiatives, we expect more than $400 million of benefits this year. These initiatives should ramp up through the year and include cost reduction benefits from the closure of our containerboard mill in Orange, Texas, and 2 pulp machine closures at our mills in Riegelwood, North Carolina, and Pensacola, Florida. We also expect higher costs for OCC as demand continues to improve and general inflation on things like transportation, wages, employee benefits, materials and services. We plan to invest between $800 million and $1 billion in capital investments for general maintenance, cost improvement and enhanced capabilities in our box business.

Other assumptions for items like corporate expense, interest expense and tax rate are included on Slide 30 in the appendix. Turning to Slide 13. I’ll outline our first quarter outlook. Before I get into the details on each of the businesses, the January winter freeze is expected to negatively impact earnings for the first quarter by approximately $40 million for the company. This impact is embedded in the numbers I will provide for each business. I’ll start with Industrial Packaging. We expect price and mix to remain flat overall. The prior index movement in North America is expected to decrease earnings by approximately $67 million. However, we expect this to be offset by approximately $68 million of commercial benefits from contract restructuring in our North American box business.

This is part of our box go-to-market strategy that Mark will discuss in a few minutes. Volume is expected to decrease earnings by $25 million due to seasonally lower daily demand, partially offset by 2 more shipping days. Operations and costs is expected to decrease earnings by $30 million. This is due to seasonality and some cost inflation on wages and employee benefits. These increases should be partially offset by lower fixed costs resulting from the closure of our Orange mill. Higher maintenance outage expense is expected to decrease earnings by $31 million. And lastly, rising input costs are expected to decrease earnings by $20 million, driven by higher OCC and seasonally higher energy costs. Switching to Global Cellulose Fibers. We expect price and mix to increase earnings by $5 million as a result of our strategy to reduce exposure to commodity pulp.

Overall volume is expected to remain stable, as seasonally lower shipments during the Chinese New Year are being offset by improved demand in other regions. Operations and costs are expected to decrease earnings by $5 million due to seasonality and cost inflation. This is partially offset by the non-repeat of the turbine maintenance outage in the fourth quarter, and lower fixed costs resulting from the idling of our pulp machine in our Riegelwood mill. As you may recall, the machine in our Pensacola mill was already idled in the third quarter. Lower maintenance outage expense is expected to increase earnings by $16 million. And lastly, higher input costs are expected to decrease earnings by $5 million. With that, I’ll turn it back over to Mark.

Mark Sutton: Thanks, Tim. I’m going to turn to Slide 14, and I’ll talk about our go-to-market strategy in our North American box business. During our last earnings call, I highlighted strategic investments we were making across our box system to create value, by improving our capabilities to serve customer needs and improve productivity. This includes adding new converting lines in existing plants, upgrading older equipment with newer, more advanced technology and new plants like the one we opened in Eastern Pennsylvania. These investments are helping us address capacity constraints in certain regions, and also address productivity related to the tight labor markets and a less experienced workforce on average. Our box go-to-market strategy is about leveraging our capabilities and strong segment-based value propositions to improve margins and mix.

It’s about making choices that create value for our customers while maximizing the profitability of our packaging business. Earlier, Tim called out approximately $68 million of earnings benefits expected in the first quarter as a result of this strategy in action. So we’re making the changes that will progress through 2024, as we continue to reset the business and strengthen our position for the future. We are focusing on value over volume. Therefore, we may trail the industry for the next few quarters when measuring unit volume growth, but we expect to grow at or above market thereafter, and we expect our earnings to improve through this process. In summary, we have significant opportunities to leverage our strong value proposition to serve customer needs, improve our mix and capture additional value.

Turning to Slide 15, I’ll update you on our strategy for Global Cellulose Fibers. First, let me say that I’m not satisfied with the absolute level of earnings that the business has produced. But as I’ve said before, I believe there is a good business within this business. And I also believe we can improve earnings and cash flows over the cycle by aligning with those customers and segments who value our differentiated product and service offerings. We believe fluff is a value-added product that will grow over time, because of the essential role that absorbent personal care products play in meeting consumer needs. At International Paper, we have talented teams with significant market expertise and a mill system with a broad set of capabilities.

This allows us to create value for our customers, by delivering innovation and products that meet their most stringent performance and product safety standards. To improve the financial performance of this business, our commercial teams have been focused on getting paid for value that we provide and being more selective in the segments that we actually serve. As a result, we have earned a higher premium for fluff grades relative to commodity pulp grades by capturing more value. We’re also improving our mix by reducing our exposure to commodity grades and by serving the most attractive customers that allow us to maximize the value of this business. Our exposure to commodity grades will mostly consist of our bleached softwood, northern bleached softwood kraft mill that goes really into tissue products and is produced at our low-cost Grand Prairie mill that is strategically located near that fiber source in Canada.

Aligned with this optimization strategy, we took actions to rightsize our footprint and reduce fixed costs across our mill system which we estimate will improve EBITDA for Global Cellulose Fibers by approximately $90 million per year. Our teams are also focused on driving out costs across our supply chain by leveraging new tools and data analytics. So in summary, we’re pulling a lot of levers in this business and expect to make meaningful progress towards our strategy in 2024. Turning to Slide 16. I’ll share some examples of how we are deploying technologies across the company in our manufacturing, converting and supply chain operations. Over the past couple of years, we’ve developed and piloted new tools and capabilities to reduce costs, increase productivity and improve efficiencies.

All of this will result in a better experience in terms of reliably providing products and services for our customers. By leveraging these new tools, we’re seeing benefits in areas such as improved reliability and lower maintenance cost higher yields on fiber, energy and chemical usage, more optimized machine scheduling at our mills and box plants, better logistics planning across our supply chain and more sourcing opportunities for operating and repair materials due to better visibility and consolidated purchases. These new technologies also enable more collaboration by connecting teams at our facilities to enterprise specialists, allowing us to maximize the opportunities. We believe there are more opportunities going forward, and this is a great example of how Building a Better IP is embedded into our culture.

On Slide 17, I want to take a moment to update you on our capital allocation actions. As I said in the past, we have a solid balance sheet, which we will preserve because we believe it is core to our capital allocation framework. Our 2023 year-end leverage was at 2.5x on a Moody’s basis, which is at the low end of our target range of 2.5 to 2.8x. Looking ahead, we have limited short and medium-term debt maturities due to the risk mitigation strategies we’ve taken over the past several years, and we expect our qualified pension plan to remain fully funded. Returning cash to shareholders is a meaningful part of our capital allocation framework. And last year, we returned approximately $840 million to our shareholders, and we remain committed to our dividend.

We understand investment excellence is essential to growing earnings and cash generation. And as I shared with you previously, we have opportunities to invest in our box system to build out capabilities and position us for future profitable growth. We also have cost reduction projects across the company with attractive returns. So turning to Slide 18. I’d like to wrap up by sharing my view that International Paper is well positioned for the future. I shared that conviction before, but after navigating another year of challenging market conditions, it bears repeating. Our financial foundation is strong, as are the principles and core values that guide our actions and decisions about how we operate, I’m confident that the winning mindset of our leadership team and our employees, and the agility of our employees will drive our success as we tackle our improvement efforts and execute the go-to-market strategy we talked about in today’s call.

As we move through 2024, we anticipate continued demand recovery across the markets we serve, along with margin and mix improvement from our commercial strategies. There’s no question in my mind that we are on the right path. Given our strategic customer relationships, talented teams, world-class assets and market expertise, we are committed to maximizing long-term value for all of our stakeholders, and we intend to deliver. With that, we’re happy to take your questions. And similar to the last quarter, our senior business leaders are joining me today to provide their perspectives in the Q&A section. So operator, we are ready to go to a question-and-answer session.

Operator: [Operator Instructions]. Your first question comes from the line of Phil Ng from Jefferies.

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Q&A Session

Philip Ng: I appreciate all the great color on some of these commercial initiatives on getting value over volumes, Mark. That’s great. Is much of this pretty much locked up contractually, so that’s it’s just flowing through. And then can you just expand a little bit on what you’re exactly doing? You effectively just walk away from lower margin business and mixing up? And then just lastly, I think you guys guided to like a $68 million tailwind for 1Q. Do we just kind of annualize that impact for the full year?

Mark Sutton: No, good 3-part question, Phil, and thank you for that. I’m going to have Tom Hamic, who’s leading that strategy from the front. It’s a 4-pillar strategy to improve the business, and it’s much more than just walking away from this, we don’t want to walk away from any of our good customers, but a lot changed over the last couple of years relative to inflation and really the attractiveness of certain segments. So Tom and his team are really putting together a thoughtful strategy reboot, if you will, on how we go to market segments and customers. And the goal is for it to work for our customers and for us, but for International Paper to improve profitability. So Tom, if you — can you maybe just share a bit about how we’re approaching the go-to-market strategy.

William Hamic: This is Tom Hamic. I would agree with what Mark said, this is really a holistic strategy for the business. So this includes everything from where we invest capital to the metrics we use to really run the business. So customers pay for value, but value in the box business starts with reliability, with quality and with shipping on time. And so we have refocused our efforts in that space. Obviously, going through the pandemic that can make that more difficult. But as we come out, we feel very positive about the metrics we’re seeing in terms of improving the customer experience. We improved the customer experience, we deliver more value, and then we charge for that value. And you’re right, there will be times when customers have a disagreement about what their price is.

There are — most times, the vast majority of times, that’s really not been the case. They’ve seen the value of IP. And in some cases, customers have left and then come back very quickly because box making is difficult and their service model is often very challenging. So that’s really the equation, provide more value, make customers know that you are important to their business and then get paid fairly for it. And that really sums up the strategy.

Philip Ng: And are these wins pretty much locked in? And then you gave some color in terms of the contribution for 1Q. Can we kind of annualize that for a full year in terms of what that upside on the commercial initiatives that you have?

William Hamic: Yes. I think annualizing it would be — that’s fair. There’s — every customer has a different relationship. There’s different timing of contracts. I am completely confident that, that number is solid and that we’ll maintain that margin structure going forward, and I expect to improve it going forward in 2024.

Philip Ng: Okay. That’s helpful. Appreciating there’s a lot of moving pieces in 2024, both on the macro front. And then certainly, there’s a price increase you guys are all trying to implement in January. But any color, just at least directionally when we think about EBITDA and free cash flow based on the control — your controllables and how you see demand unfolding. Do you expect EBITDA, free cash flow the flat or down? Just directional color would be super helpful.

Timothy Nicholls: Yes. Phil, it’s Tim. So as I said in my prepared remarks, we’re choosing not to give an outlook. It’s just — there are a lot of moving pieces. We feel good about the year. We feel like we’re in a good place in terms of earnings and cash flow but we’re not quantifying it or putting something out. We can look at it next quarter and maybe we’ll make an adjustment. But for the moment, we’re focused on the first quarter outlook, and we’ll go from there.

Philip Ng: Okay. In regards to that first quarter hangover from the January freeze, do you expect any hangover effect on to 2Q, like these costs lingering or any disruption? Or is this kind of a 1Q thing, and you guys are largely done?

Timothy Nicholls: Phil, I believe it’s 1Q and we’re done.

Operator: Your next question comes from the line of Mike Roxland from Truist Securities.

Michael Roxland: I just wanted to follow up on the focus on value over volume. Can you talk about some of the issues you noticed in your customer contracts to sort of encourage you to revisit how you price? And could this focus on value over volume involve some — maybe some additional portfolio rightsizing or maybe even distancing yourself on the publication if that publication does not actually properly reflect pricing that you’re seeing in the market?

Mark Sutton: So Mike, Tom is going to really tackle this question. But just to be totally clear, we expect long term, the business earnings growth is going to come from unit volume growth and margin improvement on that unit volume. What we’re doing right now and what Tom has described is, in the interim of resetting with this level of once-in-a-lifetime inflation and the number of other structural changes, we will pit value over volume, and then we’re going to pick value and volume or profitability and volume. So unit volume is very important in this business. It’s not a high-growth market, but you have to grow with the market long term, and we plan to do that. And so Tom, if you want to talk a little bit about some of the things we’ve seen or how we think about it. We can circle back on the question about the index and how prices are changed in this market.