International Paper Company (IP) Earnings Call Transcript & Summary

Thank you, everybody. We are delighted to be hosting next, International Paper, it's Chief Executive Officer, Mark Sutton; and our friend, Guillermo Gutierrez, who we all know form IP's fantastic Investor Relations effort. Mark will be making the formal remarks. Mark, as you know, has been Chairman and Chief Executive of the company for several years, becoming CEO in 2014, in November that year, and joined the Board in January of 2015. Prior, Mark was President and Chief Operating Officer of the company, and has had basically every job within the company over time. And he's been with the company his entire career, as I recall. Is that correct, Mark?

Correct.

And I think IP has a very interesting story to tell as the market leader. And without further ado, I give you, Mark Sutton. Mark, take it away.

Thank you, George, and thank you, everyone, that's here in person and also those that are listening on the webcast. I really do appreciate your interest in International Paper. I'd like to just make a couple of remarks before we go to just questions and answers. Just to set some context and just to update you on some of the things we've been working on. On Slide 2, before we get into the meat of the discussion, you'll see the normal forward-looking statements. I think you're all very familiar with this. And of course, on our website, we have U.S. GAAP and non-GAAP reconciliations. So I'm going to move through these statements, on to Slide 3, for those of you that are following on the webcast. I wanted to take this opportunity to talk a little bit more about something we've been mentioning over our last couple of earnings calls, but it has to do with how we are investing strategically to enhance our capabilities and strengthening our Industrial Packaging business, primarily our North American Industrial Packaging business. So just to set the framework for you within Industrial Packaging, and it is our largest business, as I think most of you that follow us know. We have annual sales of $15 billion. We have 16 containerboard mills and about 200 converting facilities. Those are -- that's our North American footprint, 16 containerboard mills and 200 converting facilities. And all of these, this entire value chain, is focused on providing packaging solutions for our customers by leveraging our capabilities, our scale, our cost structure as well as the flexibility of our system. And while we often speak about the strength of our assets, it all starts really with understanding the needs of our customers through their value chain, all the way to the end customer. So in doing so, this ensures that we are investing in the right capabilities to produce the best solutions for our customers, what they need today and, in some cases, we are able to offer after listening to their challenge as something that they may not have realized they needed for tomorrow. This could simply mean a high-profile project like our high-performance, white top linerboard investment in our Riverdale Mill. Those get most of the press. But it also means investments in our converting facilities, and those tend to be a lot smaller, a lot more distributed and very much are the last touch before the customer actually gets the finished product from us. And for me, it really all starts with the fundamental reality that packaging and boxes are tailored to meet each of our customers' unique needs. When you think about all of the combinations of fiber, fiber types, basis weights, structural design that's available and/or needed in a supply chain, the box choices that our customers have are almost limitless. In fact, for International Paper, I can put a reasonably good number on it. Our team of box designers, currently just across our North American markets, has developed almost 2 million distinct box designs for our customers. Those designs fit the need of being just the right design for how each particular application needs to bring its product to market, whether it's a traditional supply chain, from manufacturer to a wholesale warehouse to retail, or whether it's something in the e-commerce chain or, in some cases, we participate just in an intermediate section of a value chain and no consumer ever sees our package, it does a different role. So that's the reason that we've been investing more than $200 million each year in our converting business. It's all about building out the right capability and the right capacity in the right geographies where our customers are making their products. All of this, obviously, only creates value if it's at attractive returns. So just to give you some examples of what are these investments because, again, they don't rise to the level of a large mill investment. It should be a corrugator expansion, where that's our limiting factor for growing in a region. We just need to make more corrugated board that we can convert into boxes. It could also be a new converting line, or new box-making line inside of an existing plant. Also, which has been very important to our customers recently, is improved graphics capabilities, which is a combination of the liner quality, especially the outside liner, and the printing capability. So that, that package can help, in some cases, be a point-of-sale advantage for our customers. Even things like the ability to print on the inside of the box, which, up until the last few years, no one really cared about. But people care about that now, and there's some innovation involved in that. Or a fanfold machine that we actually install in our customers' operation for our form-fitted e-commerce items. We also have developed a unique small box machine for the e-commerce market that's starting to get placements now, where you get exactly the right-sized box for small, high-value items that maybe aren't a good fit for envelopes and soft-sided package, things like cosmetics and jewelry and other things like that. So in every case, the common denominator through all of this is developing solutions after listening to our customers, and trying to figure out how our package and our offering of the actual package and the service can help them succeed in their business. So moving on to the next slide. I just want to talk a minute about our graphics capabilities. So on Slide 4, our enhanced graphics solutions business is an important part of our North American Industrial Packaging system. The business today represents about $500 million in revenue and is growing at more than 3% annually. Across our North American system, we provide customers a full range of graphics solutions to meet their needs, from custom graphic retail displays to digital and preprint solutions, all of which are supported by a dedicated team of design professionals. Some of our design professionals, depending on the type of account and the size of the account and the way they like to design packages, are actually embedded with our customers. We're investing to enhance our capabilities in this area and grow our advantage. This is a very attractive market as the line crosses between the role that a corrugated package does and, in some cases, the role that a consumer package does -- does play in the market. And for example, a tangible example of this is we installed a state-of-the-art preprint press at our Tucker, Georgia facility, which has been online for 3 years. The investment cost about $20 million, and it has exceeded its return on investment commitment of 16% and is well above that. It's an important driver of some of the earnings you see represented on the chart. So turning to Slide 5 to see yet another example of how we're investing in our North American converting operations. We recently opened a $60 million greenfield box plant near Mexico City in late 2018, and is on track to achieve near 20% return. We target on these type of investments, 16% to 18% returns. And in our recent experience, we're exceeding that. Again, the strategy is to grow our advantage in an attractive market. We have a strong and successful corrugated packaging business in Mexico already, and it's fully integrated with our North American mill system. So the base material to make the boxes is largely coming from our North American system, the customers where we make the final conversion are in Mexico. Some of those products, for example, fresh fruits and vegetables actually return to the U.S. consumer market. So it's a complement to the areas that we make fresh food packaging that it's food is actually grown in the U.S. And so what the growers and the retailers do is they extend the season, as you know, by moving down to warmer climates as the seasons change. So this state-of-the-art box plant allowed us to consolidate some existing assets, and to give us the capacity to grow where customers wanted more of International Paper's packaging. And again, that theme that's consistent here, again, is providing the right solutions in the right places. When it comes to converting, you have to actually have your capability in the right geography. The tough thing about that is geographies change because the customers can move around a little bit, and you can't always pick up your plant and move it. So really doing the market research and really making sure you're lined up with the right customers who are going to be in that region. Food is a little easy because it's a bit climate based and, much like the forest, it's kind of where we locate our mills. They grow where they can grow. So we're pretty safe in putting a plant. Other type of manufacturing can relocate, and we have to manage how much investments we put in that area. So with this investment, we grew our Mexico volume by almost 3% in 2019, including double-digit growth in processed food, beverage, produce and e-commerce. Today, IP Mexico represents $500 million in revenue and has a long-term growth outlook, which is attractive for corrugated packaging, of 2% to 3%. And I'll just close on Slide 6, which is a version of what you saw, if you were involved in our last earnings call. It shows International Paper's trend of, I think, a couple of really important metrics, strong and resilient free cash flow and solid returns above the cost of capital. In the previous slides, I just shared a few examples of how we're investing in our North American box system to drive organic growth and attractive returns. All of these investments contribute to our sustained margins in this business above 20%. When you step back and look at our capital investments during the last few years, we're coming off a relatively high capital investment cycle for International Paper as we completed some larger strategic mill projects. And as a reminder, some of those projects were to give us system flexibility so that we could make more of the same product in different mills to take advantage of the freight market, velocity to take advantage of the backup capability to allow us to run our system at various levels of output and not impact any customer negatively. There was also a system-wide cost reduction in input materials consumption. But that's largely behind us now. We won't have those type of projects every year. And that's why we can expect our capital spending, and we communicated to be no more than $1 billion from an average of $1.4 billion the last several years. Our 2020 number is about $1 billion, and we're still able to do the $200 million of high-value investments in our converting business inside of that number. I get questions sometimes about what changed, and that's what changed. We had some big projects in a cycle. We don't have those now. They're all in place, and we're enjoying some of the benefits of those, and will for many years to come. And now the next phase is making sure we can provide -- convert that high-quality board into more and more boxes and packaging for our customers. And those investments are just a lower level of money to get them done. So I've often commented on our ability to succeed and generate strong free cash flows through practically any set of conditions. I know that's a pretty strong statement. But through any kind of ups and downs, we tend to be able to pull the levers we need to pull so that investors can depend on IP being a strong cash generator. And we return a significant amount of that cash even after these investments, through our dividend and share repurchase strategy around our capital allocation framework and maintaining an investment-grade balance sheet. So that's what our commitment is. I think we've demonstrated it over several years, and we plan on continuing to do that. So with that, George, I would be happy to take some questions and see what's on everybody's mind.

Okay. Thanks for that, Mark. So one of the -- I think subtle points you're trying to perhaps get across, and you feel free to agree or disagree with this is, hey, investment community, we are more than a roll of containerboard. We're more than -- even though it's important, a price index, that the community tends to focus, understandably, on and look at the cash flow and look at the -- how much value have you returned over the last 2 years. I think it's up -- close to $3 billion between dividend and buyback. So are you trying to change the narrative here?

I think we are. On capital allocation, we are. I mean a lot of the company we are today was built through a series of consolidation moves in some key markets. So that involved a fair amount of M&A. We like what we've built, and now it's our opportunity to really optimize it. So that's a bit of a narrative change. And we're going to generate a lot of cash. We're going to invest in the business so that we can protect today's cash flows. That's a lot of what the kind of unexciting maintenance capital goes to. But I have always reminded people, we spend twice as much as that just in expense to maintain and protect our facility's current cash flow. And then, strategic investments that help us improve with customers, primarily. There are some strategic investments that are really about cost. And those are fun to do because they can be unique to IP. And we get a differential improvement in our margin that's not related to market price, so things like how much fiber we use in a mill, how much energy, how much other input materials, chemicals. So those are the things that we invest in. But I think the narrative around generating cash and being responsible stewards of that cash, I think I get good feedback on our dividend. It's been raised for 10 years in a row. It's got a strong, sustainable, trough-tested 40% to 50% of free cash flow guideline that we use. We haven't been consistent with share repurchases. It's been episodic in IP, a big part of that is. I think we did the right thing financially, but it is what it is. We had a lot of work to do to derisk the company, really, since 2014, '15 and really fixing our pension. So I wish we wouldn't have had to do that, but we did. And it was the right thing to do, from a balance sheet standpoint and presenting our company to investors, that was an appropriate level of risk. But that was cash that couldn't be invested. It couldn't be returned. It did a nice job of improving the balance sheet, but it's behind us now. So one of the first things I tried to do in this period, that you mentioned, when I became CEO is look at the company we had, recognize not everything was working and recognize that we had some risk on the table, mainly via our pension. And the stuff that wasn't working was some of our international investments. We've moved away from all of that, and we took the pension risk off the table. And then we began to invest into our core businesses of Industrial Packaging. We believe, in the future, we can have a strong position in the high end of specialty pulp, our cellulose fibers business. And we've managed our paper business for cash. And for -- in some cases, a few asset conversions into our core businesses for the future. So that's where I'd like people to understand. That's what International Paper is about today. And I think the only way to get investors to understand is to do it.

Well, makes perfect sense. One question I had for you is as I was looking at your presentation -- by the way, the 2 million discrete box designs that you have, what period was that over? Is that your current warehouse? Or how should I interpret that 2 million?

I would think of that as the current offering we have available to the market. So when you develop a box for 1 application, sometimes a minor adjustment to that design can work in another application. The reason that happens is because everyone's supply chain can be a little bit different in individual customers. Remember, we think of boxes, and we think of the big national accounts. And we all think about our own anecdotal experience about what a box of toilet paper or whatever it looks like. That's less than half of the box used. The other half is smaller customers making unique products with a unique supply chain, maybe it's only regional. And those boxes don't get the same level of attention, but that's where a lot of the design, differences and uniqueness are. And for some case -- in some cases, those customers view the package as part of their offering to the customer -- even the corrugated package as part of their offering to the customer. And there's just a lot more opportunity to fine-tune designs. And so that's our current inventory. We don't always use all -- we don't have 2 million active at any one moment in time. But there is a lot of differences that seem innocent and simple, but they play a pretty important role for customers.

So one of the questions I had around this, and it piggybacks on 1 of the other companies, although they're not in the corrugated business, that talks about managing complexity and ultimately getting a return for that. Would you say that 2 million, to me, this is not the right way to illustrate it, but I'll use it. Has that inventory grown at a quicker rate in recent years? Has the complexity in your business increased, which isn't necessarily a bad thing if you actually get paid fairly for it. So how would you have us think about how IP is facing that and using that?

So one of the things that's changed in our industry and in everybody's industry is the ability to manage complexity. So yes, 2,000 designs is more complicated to manage than 100 designs. But the development of technology and software and the computer-aided design characteristics, the prototype machines that are in our plants that allow us to design, test and fail soon, and move to the next one and then find the winner, is so much simpler now. So in that particular part of our business, we are benefiting, like a lot of industries are, by the technological revolution of the power of data, the power of sharing, the power of computer-aided design and the way we actually build samples and prototypes. It used to be very manual, almost production-size work, and it's evolved now into a very quick, very precise, almost laboratory-size work. And that has helped us manage the complexity. So I would say, if you talk to our people in our box plants, the level of offerings we have, which are exponentially more than we used to have, with the tools they have to use, probably no more complex and a lot more interesting to do.

Thank you for that. Does the fact that it's actually made your life perhaps a bit simpler, not yours specifically but IP in general, in terms of managing that complexity, does -- how is that then translated in terms of how you handle the marketing of IP's services and the commercial aspects? I know you can't get too much into pricing, but could you share what's changing as a result of the greater number of designs but, at the same time, the -- to some degree, the increased simplicity in terms of managing that process?

So one of the ways we can turn that into value for IP, and if you just look at some metrics that would give you an indicator, we have a big export position in containerboard and it's a bit more cyclical. And that number, whether it's really good or not as good, is in our margins. And our margins are competitive with companies that have only a North American exposure for board and box. So what does say about the part of our business that's not export? We don't give that number out, but it is a really strong way to go to a customer and say what is the value we can create. And many, many customers, not all customers, but many customers are willing to have that conversation because they're smart and they want value. "Lacking any value offering, they would just match the lowest price I can buy this box from because no one's offered me anything different. I got 4 suppliers. Why wouldn't I? I mean I would be ridiculously inept if I didn't ask for the lowest possible cost." But if you work on a more market-based value mindset and look at what the customers' opportunities are with a different design, all the way through their value chain, you might get a higher price for your box, and they actually make more money because it took cost out of their system. Or if it's a point-of-purchase opportunity, it clearly helped them sell more product. It's more difficult in our industry to come up with something that no one else can absolutely come up with a competitive design for. And that is true because it is the nature of the product. But embedding our designers, working with customers who we already have a large share of their business and trying to win more of it, and then offering things to the smaller customers that really help them, those are the customers that are growing the most. That really helped them meet their objectives is a way to get the conversation beyond just the price of a normal brown box.

Understood. Any questions on this topic from the audience? In terms of complexity, design, value, without getting into the specifics, over time, could you see and have further evolution in terms of how IP sells value and, for that matter, prices its boxes? Or should we expect more of what we've seen past this prologue?

Well, I think there's -- again, there's a couple of sections to the market. Pricing is done in a customer-specific, unique way. Price changes are governed, in many cases, by an input cost index, like the containerboard index. Some of that was created for just a simple way to manage it. And if you look at history, it doesn't -- it's actually -- it doesn't move around all that much. We live in the moment, so there's been a few adjustments recently. But if you just look at the big picture, what customers want is what is a trigger for us to discuss. And it's common in materials industries for your cost inputs to be part of the conversation with customers about how you price your product, and it happens in almost every basic material industry. This one's a little harder for people to understand because it doesn't set the price of the product, it sets the conversation for possibly changing the price. But I can tell you, the price of the product is set with a negotiation, and you have to assess who am I competing with, how much do I need this business. So every company has a slightly different calculus for that. And the reason for that is when you look at a box system, you have these distributed plants that are revenue centers. We manage ours as P&L centers, so we have general managers that are out to run small businesses, $50 million a pop in revenue for a box plant. They have a certain customer universe that's accessible to them, physically accessible, where they can ship, make money and all types of customers. What they're trying to optimize is in a converting operation, what you have to sell is value-added time. So for their plants, or the IP plants in that region and for the customers that are available, what is the best mix of business that I can make the most profit per hour? And for another company, who maybe only has 1 plant in that region, that calculus is different. I need 2 big customers. I need to run the same box all day and that maximizes. So you may not be competing with that particular supplier for some of the smaller, more difficult-to-do business. You may be competing with 4, 5 smaller companies who are very good at that. So that's what I meant by market-based. You have to understand what the market is. And it's not just IP and the customer. And it's not just the macro environment. The market includes your competitors. It includes your own profit formula, in terms of that profit for our mindset. And that's how we approach our offering to a customer. For simplicity, especially for the large customers, they -- boxes are important, but they got a lot bigger things to do. Usually, we're a small part of their overall cost. They just need something that's simple to manage the changes. And they wouldn't want to manage. And we've talked to customers about it. They wouldn't want to manage monthly and weekly and adjustment. They just want to be able to plan, to some extent, around their packaging. But winning that business is a totally separate process than any kind of index.

That's very clear, Mark. Thank you for the color. Question at the back. Greg?