O-I Glass, Inc. (NYSE:OI) Q4 2022 Earnings Call Transcript

O-I Glass, Inc. (NYSE:OI) Q4 2022 Earnings Call Transcript February 1, 2023

Operator: Hello, everyone and welcome to the O-I Glass Full Year and Fourth Quarter 2022 Earnings Conference Call. My name is Davie and I’ll be coordinating your call today. I would now like to hand the call over to your has Chris Manuel, Vice President of Investor Relations, to begin. So Chris, please go ahead.

Christopher Manuel: Thank you, Dave and welcome, everyone, to the O-I Glass full year and fourth quarter earnings call. Our discussion today will be led by Andres Lopez, our CEO; and John Haudrich, our CFO. Today, we will discuss key business developments and review our financial results. Following prepared remarks, we will host a Q&A session. Presentation materials for this earnings call are available on the company’s website. Please review the safe harbor comments and disclosure of our use of non-GAAP financial measures included in those materials. I’d now like to turn the call over to Andres, who will start on Slide 3.

Andres Lopez: Good morning, everyone and thanks for your interest in O-I. We are very pleased with O-I’s performance in 2022, our results exceeded guidance and we achieved all of our key commitments. Last night, we reported adjusted earnings of $2.30 per share which represented more than 25% increase from the prior year results and exceeded guidance. As you can see on the left, we have very good business momentum, with consistent adjusted earnings growth over the past several years. The strong results reflected solid execution across all key business levers. Earnings benefited from significant net price as well as sales volume growth, good operating performance and our margin expansion initiatives. Importantly, Full year free cash flow and fourth quarter results also exceeded our most recent business outlook.

In fact, this represents the 12th consecutive quarter we have met or exceeded the Street consensus. In addition to a strong operating performance, we also achieved all of our key strategic objectives in 2022. Margins were up and we initiated our capacity expansion program to enable profitable growth that includes our first MAGMA greenfield plant. We also significantly improved our structure as Paddock result is legacy as best related liabilities and we completed our portfolio optimization program. As a result, we now have the healthiest balance sheet in the past decade. Reflecting solid business momentum, we expect our performance will continue to improve in 2023 as we further advance our strategy. John will expand on our financial performance and outlook a bit later.

Let’s move to Page 4 as we review recent sales volume trends. As expected, shipments increased about 1% in 2022 following significant growth in 2021 when volumes rebounded from the onset of the pandemic. While demand remains healthy, our growth has been limited by capacity constraints and record low inventory levels in key markets. Growth was most notable in the spirits, wine and NAB categories, while beer and food were slightly down. Shipments increased nearly 4% in Europe and were up across all end use categories amid a strong underlying demand and glass supply constraints. Volume declined 1% in the Americas, primarily reflecting lower production due to planned and unplanned downtime in North America and Brazil, while we contended with record low inventories across Latin America.

Consistent with guidance, fourth quarter shipments were down about 3% given the challenging prior year comparison when volumes were up a robust 5.4%. Looking to the future, we anticipate continued healthy demand as illustrated by Euromonitor projections, indicating average annual growth of 2% to 4% in the key markets we serve through 2025. Overall, we expect our shipment leverage would be flat to up 1% in 2023. The first phase of our expansion program will add much needed new capacity. However, this benefit will be tempered by record low inventory levels and the impact of higher asset project activity as maintenance initiatives normalize and supply chain . Stronger shipment levels are anticipated in 2024 as more new capacity comes online. Overall, we have not seen significant changes in demand patterns slightly but we’ll continue to monitor market conditions given the risk of recession.

Let’s turn to Page 5. On top of the strong recent performance, we also achieved all 2022 key strategic objectives. Segment operating profit margins were up 110 basis points as we exceeded our targets for both net price realization and margin expansion initiative benefits. As noted, our capacity expansion projects are progressing well as we capitalize on the strongest glass fundamentals in at least 20 years. All MAGMA development efforts are advancing well and we have broken ground on our first MAGMA greenfield in Kentucky. Likewise, the full-scale market trial of our new ultra-light weighted solution is proceeding well. Our ESG and Glass Advocacy efforts continue to advance. As discussed, we significantly improved our structure as Paddock result is legacy asbestos-related liabilities and we wrapped up our portfolio optimization program.

I want to thank the O-I team for advancing our strategy and achieving all key objectives in 2022. We have established another set of ambitious and achievable objectives to advance O-I’s strategy in 2023, as shown on Page 6. Higher earnings and margins should benefit from a strong net price realization and our ongoing margin expansion initiatives. As you can see, we have increased our annual initiative target to more than $100 million which now includes a set of focused initiatives to advance performance across targeted operations primarily in North America. Efforts include growing in attractive markets in North America, supported by our ongoing expansion program. Likewise, we recently closed one low-margin furnace and are in the process of closing 1 more low-margin forgers in the near future.

Currently, we are distributing that volume within the network. We also intend to improve our commercial position as we reset over 40% of our customer agreements with more favorable price and terms and implement current price adjustment formulas which will recover significant prior period cost inflation. We are off to the races and expect to advance our capacity expansion program to enable profitable growth. We aim to complete our Canada and Colombia projects during the first half of the year as we continue the next phase of projects in Brazil, Peru and Scotland as well as our first MAGMA greenfield in Kentucky. Additionally, we will advance our MAGMA development efforts that will enable commercialization of both Gen 2 and Gen 3 in 2024 and 2024, respectively.

Likewise, we expect to complete the ULTRA qualification in Colombia that will pave the way for future deployments. We intend to accelerate the use of key technologies to help reduce greenhouse gas emissions on top of a set of initiatives to expand recycling rates. We will advance our Glass Advocacy campaign and increasingly prioritize B2B connections to build the O-I brand with decision makers. Finally, we will continue to improve the capital structure and expect to reduce our net leverage ratio to below 3x by the end of 2023. I’m highly confident these efforts will advance our strategy as we continue to transform O-I. Turning to Page 7. We are very excited about our first Magma greenfield plant in Bowling Green, Kentucky which is on track for initial commercialization of Gen 2 by mid-2024 and yet by mid-2025.

We are designing the plant to be a showcase facility that will demonstrate all of our next-generation capabilities. This new state-of-the-art facility will include the MAGMA melter, new melter batch system and pilot forming machine. It will be fully digitized with a high-performance operating structure. This highly scalable plant will eventually include all MAGMA generations, with advanced sustainability features as well as ultra-light weighting system. Located in the Volvo trail, the plan will demonstrate the value of near locations and will be a key hub for further customer collaboration, investor visits and demonstration of O-I’s next-generation capabilities. I invite you to review a recent video that we created that shows MAGMA in action and further discusses these many important attributes.

This slide includes the link to the video. Now, I turn it over to John to review financial matters starting on Page 8.

John Haudrich: Thanks, Andres, and good morning, everyone. O-I reported full year adjusted earnings of $2.30 per share which exceeded guidance and increased 26% from the prior year. In fact, performance improved across several key financial measures, as illustrated on the left. Earnings improved in both the Americas and Europe as segment operating profit increased to $960 million, reflecting strong net price realization as well as modest sales volume growth and solid operating performance despite higher asset project expense. Turning to the fourth quarter, we reported adjusted earnings of $0.38 per share which was up from the prior year and exceeded guidance. Results increased 36% from the prior year when adjusting for FX divestitures and interest in funding the Paddock Trust.

Fourth quarter segment profit was $206 million, up more than 25% on an adjusted basis as margins increased 100 basis points. Strong net price boosted earnings and as expected, sales volume was down about 3% given challenging prior year comps. Finally, operating costs were up, primarily reflecting elevated asset project activity. The Americas reported $83 million of segment operating profit which was down from the prior year on an adjusted basis. Earnings benefited from favorable net price, while sales volume was down 6% amid elevated project activity. As expected, higher operating costs were partially offset by our margin expansion initiatives. In Europe, segment operating profit was $123 million, up $52 million from the prior year on an adjusted basis.

Very favorable net price boosted earnings while operating costs were up as noted. The chart provides additional details on nonoperating items. Yet again, the company delivered strong earnings and margin improvement despite the highly volatile macro environment. Let’s turn to cash flow and the balance sheet, I’m now on Page 4, rather, Page 9. As shown on the left, we reported free cash flow of $236 million which exceeded guidance, yet was down from the prior year due to higher CapEx given expansion project investment. Adjusted free cash flow which excludes the strategic CapEx, totaled $426 million, an increase from the prior year, demonstrating O-I’s improved operating performance. In fact, our cash flow conversion was around 36%, well ahead of our 25% to 30% goal.

At the same time, we have significantly improved our balance sheet position. As shown on the right, total financial leverage was around 3.4x at the end of the year, down 1x from last year and 2x from 2020. This improvement reflects higher earnings, solid free cash flow generation and proceeds from our portfolio optimization program, while funding the Paddock Trust. In fact, we achieved our 2024 Investor Day goal of 3.5x leverage well ahead of schedule. Recognizing our progress, both Moody’s and S&P increased our credit rating this year and we now have one of the better balance sheets in the rigid packaging sector. In summary, core operating cash flows improved and our balance sheet is in the best place in a decade. Let’s discuss our 2023 business outlook.

I’m now on Page 10. Overall, we have very good momentum heading into the new year. Earnings will benefit from strong net price realization and flat to modest sales volume growth. Operating costs should be up due to elevated asset project activity, partially offset by the benefit of margin expansion initiatives. As a result, we anticipate adjusted EBITDA should exceed $1.37 billion, an increase of 15% from 2022. Full year adjusted earnings should exceed $2.50 per share, reflecting very good EBITDA improvement, partially offset by elevated interest expense. Overall, we expect earnings will be front-loaded in 2023. Net price realization will likely peak in the first half as earnings benefit from annual price adjustment formulas that recapture prior year inflation and new increases effective in January of 2023.

Likewise, we will lap the prior year 3 price increases over the course of the year. As such, we anticipate earnings will be up nicely during the first half of the year, while second half results could be more comparable to 2022 levels. You can see that reflected in our first quarter guidance of $0.80 to $0.85 per share which is a significant increase from the prior year, reflecting strong net price and the benefit of inventory revaluation due to elevated inflation. Given macro uncertainty and the risk of recession, we are providing base performance levels for full year 2023 rather than an EPS range at this time. We do intend to introduce an earnings guidance range in a quarter or 2 once there is greater market clarity. Adjusted free cash flow should increase to at least $450 million and free cash flow should be at least $150 million which is down from the prior year due to elevated CapEx approximating $700 million to $725 million.

Higher CapEx reflects increased expansion investments as well as normalized maintenance project activities as supply chains improve. As Andres mentioned, our leverage ratio should end the year below 3x as we continue to focus on balance sheet improvement amid a higher interest expense environment. Overall, we are optimistic as we enter 2023 and expect continued positive momentum despite ongoing macro uncertainty. While intentionally cautious on the back half of the year, we are well prepared to manage through elevated volatility as we have done over the past 3 years. Importantly, we have already achieved all of our key 2024 financial targets, as presented at our most recent Investor Day, well ahead of schedule and our 2023 guidance exceeded those goals.

Given the foundation we have established and good momentum, we anticipate continued performance improvement in 2024 and beyond and expect to introduce new long-term targets once macro stabilize. Let me wrap up by restating our capital allocation priorities. I’m now on Page 11. Improving our capital structure remains our top capital allocation priority. As noted, we expect leverage will end the year below 3x. We will continue to reduce debt consistent with our glide path to 2.5x leverage and expect to eliminate our net unfunded pension liabilities over the next few years. Our second priority is to fund profitable growth. This includes our current $630 million expansion program. We do anticipate continued modest portfolio optimization as we seek to increase ROIC which could also help with debt reduction or expansion.

Returning value to shareholders is our final priority. We will continue our anti-dilutive share repurchase program. Likewise, we may evaluate additional share repurchases or reinstate dividend as we get closer to our capital structure objectives. Thank you and I’ll turn it back to Andres for concluding remarks.

Andres Lopez: Thanks, John. In summary, we are very pleased with our performance in 2022. Adjusted earnings per share increased more than 25% from the prior year and exceeded guidance. As noted earlier, we have met or exceeded the Street consensus for 12 consecutive quarters. In addition to strong performance, we also achieved all key strategic objectives in the past year. We increased margins, initiated our capacity expansion program, advanced breakthrough technologies and significantly improved the structure of the company. We have a strong momentum heading into the new year. As such, we expect higher results as we continue to advance our strategy in 2023 and beyond. Finally, I believe O-I represents an attractive investment opportunity as we strengthen our financial profile, execute our transformation program, enable profitable growth, advance breakthrough innovations like MAGMA and ULTRA and further leverage our sustainability position going in the new green economy.

We are confident this strategy will create value for all stakeholders. Thank you and we’re ready to address your questions.

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Q&A Session

Operator: Our first question today comes from Ghansham Panjabi from Baird.

Ghansham Panjabi: Anders, looking back at 2022 on a segment basis, I mean, Europe was up 320 basis points from a margin standpoint year-over-year, up significantly versus the pre-COVID level. And obviously, there was a lot of chaos last year with European natural gas and so on and so forth. How do you think this evolves from a margin structure standpoint, specific to Europe if, for example, natural gas prices or energy costs more broadly revert towards pre-war levels?

Andres Lopez: Thank you, Ghansham. Well, if we look at the demand fundamentals in Europe, they’re very solid. In 2022, all in users, beer and AB food, wine and spirits performed quite well. So this is happening across markets in Europe and across end users. When we look at the wine and beer demand, for example, so Champagne, Prosecco, Italian wine in France and Italy, it is particularly strong. And you know these 2 markets are very large and relevant markets for O-I. Spirits in the U.K. is very strong, too. Now along with that, we mentioned before, there is a large shortage of glass in Europe that is driven by all this growth that I mentioned, plus the capacities locations that are up to 1 million tons, about 4% — 5% of the total supply.

And we believe this is going to take several years to be resolved, right? So from a demand standpoint, we see this continuing. When we look at the gas prices, we’re continuously looking at the TTF futures. And when we look at those futures, that — they suggest to us that this is going to be a multiyear dynamic. And today, we’re dealing with a milder winter. This is — there is still winter to go, that we will be facing replenishing the storages, most likely dynamics are going to change at that time. So I think we’ve got to see how this unfolds. But you will expect that many users of natural gas bought position in the second half when prices drop a little bit, most likely they’re buying positions today and that will take most likely care of 2023.

So we’re out of this year into the following years. But back to the TTF futures, when we look at them, they suggest this is going to be a multiyear dynamic. And back to Europe performance, the European performance improvement has been a long-term trend. Since 2015, every year, we’ve been up in earnings and margins and returns. And we’re seeing the continuation of that. I think we’re very well organized and prepared in Europe to really drive value out of that very important market.

Ghansham Panjabi: That’s very helpful. And then for the first quarter, can you quantify the inventory revaluation benefit? And then also related to that, you’re pointing towards $100 million plus margin expansion initiatives for the year in terms of benefit. Can you just give us a bit more color as to what that’s being driven by?