International Paper Company (IP) Earnings Call Transcript & Summary

Good morning, everybody. Welcome back to the 2020 Goldman Sachs virtual industrials and materials conference. We're very happy to keep it going with the virtual format here. And thanks, everybody, for participating and making all the necessary adjustments to join us via webcast this year. Our next presenting company is one of the largest global packaging companies, one of the largest producers of containerboard in North America. And of course, it's International Paper. Very pleased to welcome CEO, Mark Sutton, to the conference. Mark's going to open with a brief introduction and then we'll transition over to the fireside chat portion of the presentation. [Operator Instructions] But with that, I just want to turn it over to Mark. I think he just want to make a couple of brief remarks before we get into the fireside chat portion. Mark?

Thank you, Brian, and thank you to everyone listening on the webcast. I really appreciate your interest in International Paper. As Brian said, I'll make just a few brief remarks before joining Brian for questions. I'd like to note as we start that we do not have any slides today posted for the conversation. And as a reminder, actual results may differ from any forward-looking statements I may make today as a result of risks and uncertainties that are disclosed in our press releases and SEC filings. Also, our website has the GAAP reconciliations of any non-GAAP financial measures I may discuss or mention today. As far as these virtual formats go, this week marks a couple of firsts for International Paper. On Monday, we held our Annual Shareholders Meeting as a virtual event. This was the first time in our company's 122-year history that we did not conduct the meeting in person. And this conference today is the first one that we're participating in using this format. So clearly, we're doing our best to adapt to this dynamic world. What does not change, though, is our commitment to manage the COVID-19 crisis with a view towards the short-term and the long-term success and sustainability of the company for all of our stakeholders. We'll discuss some of the moving parts in more details in a minute, but let me first highlight a couple of points I made on our earnings call 2 weeks ago. First, International Paper entered the COVID-19 crisis in a position of strength with our diverse customer base, our world-class manufacturing and supply chain capabilities, our strong balance sheet and liquidity position and, most importantly, our talented and committed team of 50,000 employees. And second, International Paper is a critical part of the supply chain required to produce and deliver essential food, pharmaceutical, hygiene products and emergency supplies to consumers around the world. And as we start to see parts of the economy reopen, we will continue to abide by our principles of keeping people safe, taking care of customers and strengthening our liquidity. We'll continue to take prudent steps to further strengthen the company so we're well positioned for an economic recovery as it unfolds. And with that, Brian, I'm happy to start with the Q&A and the fireside chat.

Yes. Thanks, Mark. I just wanted to also echo some of the sentiment around how we're all adjusting to this environment. I've been very impressed with the business community and the investment community, just everybody being resilient enough to sort of adjust to all these working-from-home conditions. And still, things seem to be functioning pretty well. So again, it's just maybe kind of a testament to how resilient we've all become in the current environment. But with that, I wanted to -- what we're really trying to -- I think what investors are finding the most valuable in the conference and in these presentations is to try and get some real-time updates and real-time data. You came off of an earnings call where you talked about trends in April, and it seemed like we've heard from some others in the industry that maybe things decelerated a little bit towards the end of April, maybe they've stabilized a little bit in the last week or 2. But with the benefit of an extra week or 2 since the earnings call, I was hoping you could just update us on what you're seeing on the demand side, particularly in corrugated with box shipments. You came off of a strong March, April. I think you said that was up in the neighborhood of 2%. But I was hoping you could give us a little bit more real-time color on what trends you're seeing there.

Sure, Brian. I'd be happy to. We -- as we said in the earnings call, what our comments were anchored on, on our outlook was our best view at the time. And as you know, as you said, our earnings call was 2 weeks ago. We obviously had a very strong end of the first quarter, with March especially, as place -- as the economy began to close and supply chains began to be rerouted and consumers started to stock up basically. And so May is coming in as we expected. We mentioned stepping down from the elevated levels we saw at the last part of the first quarter, and that's happening. If you recall, we were up almost 5% in March. However, we have seen some improvement in the past few days. So I would say our comments on the earnings call, as we went through the rest of April and as now we're 2 weeks into May, are about as expected with some positivity in the recent days.

And that's great to hear. And there's a couple of specific end markets that we've gotten some questions from people on as far as how the virus is impacting them maybe with a little bit of a delay. Foodservice, obviously, had a tough go there in March and April. Just wondering if you're seeing some improvement in those trends as some restaurants start to open up. And then the other one we get asked a lot about is the protein markets with some of the meatpacking plant disruptions that sort of cropped up in mid-April there, if you've seen some softness in that market or maybe some signs of stabilization in recent days.

Yes. So the protein market, I'll start with the second question first, is really important for International Paper. And the interesting thing, I think everyone has been tracking this because it's been in the news, is that the consumer demand for meat and poultry and the products of the protein category remains very strong. There have been some supply disruptions. For International Paper, we have an advantaged position, and we're overweight in this segment, meaning we have a larger position in that segment than the segment represents for overall corrugated demand. We are experiencing some short-term negatives from the processing plant stoppages. Many of the shutdowns are now ending, and the plants are restarting. And so as we see our backlog, it's very strong from all of our customers across the protein spectrum. I think the recent stoppages, the attempts to -- for the companies and government guidance to try to get the plants to be more reliable, keep the workforce safe really kind of reinforces the importance of this part of the supply chain as a major food source. So we're hopeful that, that supply chain is going to improve over time, and we're seeing some signs of that. On your first question, on the foodservice supply chain mainly to restaurants and other non-at-home food, obviously it should correlate, and we'll begin to see that now because of the nature of our business. On my way in, I came to the office today, I saw several foodservice trucks from the big national foodservice suppliers delivering to restaurants in the Memphis area that had been closed. So it was a very good sight to see a full tractor-trailer bringing supplies to restaurants. And we should see that and are beginning to see that in our order books given there's only a couple of weeks max of cycle time. So as jurisdiction, cities and regions begin to open, that part of the supply chain is a source of potential upside. When we talked in our earnings call, Brian, that was April 30 and it was still very unclear what the reopening plans were going to be, many things were announced in the first week of May to take effect about now. And so we're going to keep our eyes on that, and we are seeing some signs of movement through the foodservice supply chain.

That's good to hear. It's definitely good to see some of these cities reopening. Down here in Houston, we've started to slowly kind of reopen the economy and get people back out to restaurants. So hopefully, that keeps continuing without a big tick-up in infections here. Just to think about the recession we're in, we've gone through a couple of different recessions in the industry. When we look back to prior periods where GDP has contracted, '01-'02, '08-'09 probably the 2 most recent examples, it looks like we do see a sharp drop in box shipments, and then it takes many, many years to really get back to the prior levels for whatever reasons. I mean I have some of my own theories, but I was interested if you could kind of comment on if you think things will be different this time around, if you think either the changing complexion of your mix will make the volume declines less sensitive to GDP and if there's anything else about the current recession that might make volumes snap back a little bit faster than they have in prior downturns.

Yes. That's a complicated question. As you mentioned, we all have different models and theories. It definitely was a slow return from the '08-'09 crisis. The cause, obviously, was different than this particular disruption. I think it's going to depend really segment by segment on how the recovery unfolds. I mentioned on our earnings call -- and I know this is obvious to everyone, but the consumer sentiment hopefully improved by therapeutic medicines to treat the conditions if you do get this virus and, ultimately, if we can get a vaccine, none of which -- none of these are absolutely sure, but they look like they're on a positive trend. That'll have a lot to do with the shape of the recovery that drives box demand. So we're going to watch all of our model inputs very closely. But I'll just take it up one level, Brian, and say that over time, lots of moving parts about what affects box demand, but box volume is going to track with nondurable manufacturing. So the amount of nondurable products we produce and then either ship in the country and consume here or ship to export markets is going to be the best single overall correlation to box demand over time. So watching all those subcomponents in that nondurable category is what we pay the most attention to.

And you mentioned the export markets there briefly, but just wanted to talk about -- that seems like it's been a bright spot for the industry. The comps are easy on a year-over-year basis because it was a little bit weak to start last year off. But just interested to hear your thoughts on if you're seeing continued strength in those markets. The stronger dollar, I guess, would be a little bit of a headwind, I would think, directionally. And obviously, the economies are weak in many of those markets. But we've been kind of surprised how resilient the export market's been. Just wondering if you could tell us if that's kind of continued in recent weeks.

The export markets or -- for International Paper or our kraftliner market's where that product is the best solution for the particular type of packaging. And it's really in 2 areas. It's fresh foods, fresh fruit and vegetable and other fresh foods and then any kind of heavy-duty or high-value packaging. And so that's what we serve. That's the supply chain we serve. We have longstanding customers. And so in -- if you take our position in Latin America and the Mediterranean, we have very, very strong positions in the agricultural supply chain that uses kraftliner. And consumer habits are different. In the U.S., produce through the grocery store hasn't matched the produce that was going through the restaurants. But in Europe, produce, fresh foods are the way people eat and sustain themselves pre COVID-19, during COVID-19 and it will be that post COVID-19. I think that's part of the reason you're seeing some of the strength in those markets, is that the kinds of items that go in that packaging are still very strong and very, very essential.

Great. That's great to hear. One of the end markets that's been definitely a bright spot for not just in recent months but the last couple of years, but it seems like it's kicked it up a gear, is e-commerce. And it's a fast-growing segment before COVID-19. It seems like with the lockdowns in effect, a lot of people are buying more and more things online, things that maybe in the past they didn't even know or weren't really comfortable buying online. And we've seen a big uptick in volumes, and you benefited from that. We had one of your peers yesterday. I think they said e-commerce was up 24% for them in April. I think we heard you guys talk about similar kind of high double-digit rates there. So I guess just the question is really just around the evolution of e-commerce, if you think that, that is going to be a lasting trend coming out of this crisis, that more and more will be bought online. And as you think about corrugated usage in e-commerce versus brick-and-mortar retail, there'll be some negatives because brick-and-mortar retail will be lower. But net-net, we've heard anywhere from 2 to 3x more corrugated usage in e-commerce versus retail for the same item. So do you think that we're going to kind of be sustainably in a higher level of e-commerce as a portion of the mix of boxes going out the door after the crisis?

Look, I think on our earnings call, Brian, we talked about strong, double-digit growth on top of what was double-digit growth for International Paper. And I might have even -- I think I even said order of magnitude strong, double-digit growth. And we're still seeing that it remains a very strong segment. We are an active participant in multiple types of e-commerce. The most famous, of course, is direct-to-consumer, but there are other areas of e-commerce that are strong for us in the industrial side and business-to-business side. And so for International Paper, it's been a focus of ours through product development, through supply chain services, through machinery, and it continues to be. We see -- with all the puts and takes you talked about, an e-commerce box and what it does to displace the prior supply chain, we see it as a net positive. And that's what our experience has been. If you really wanted to know the detail on how much more or less corrugated is used, it would be quite a project because of the differences in packaging, supply chains, all the variables. But when we look at the fact that we're in almost every segment that's using e-commerce as a channel to market, we see it as a net positive in our actual results.

I wanted to switch over from the volume side to the input side a little bit. The other big news in the last couple of months has been the spike in OCC costs. And I think besides trying to figure out how much corrugated is used in e-commerce, another great project would be to figure out what drives OCC prices and where they're headed because it's as volatile a commodity as I've ever seen. So we're kind of back up about $80 a ton so far in the year. It came in the year obviously at really low levels, kind of multi-decade lows, and now we're back up to maybe the average we saw over the last 10 years or so. But obviously, that's -- it seems like a supply shock related to the virus. I guess as you're thinking about how that impacts you both from a financial and an operational point of view, are you able to swing some of your capacity back to virgin? Are we at that point where OCC is maybe disadvantaged versus virgin fiber and you're looking to swing as much capacity back over to virgin as you can? And how quickly can the system adjust production to these kind of swings in input costs that we see?

Yes, it's a great question, and we have our own unique fact set inside of International Paper. On a typical steady-state world, we're around 35% recovered fiber in our mix and the balance virgin fiber. There is swing capability in there, and we do it all the time. When we comment in earnings calls about prior quarters, production and economic downtime and all those things, we talk very much about marginal cost analysis in the choice of fibers because we designed the containerboard to a specification, and it allows us to have some ability to move the fiber around. And then, of course, there are qualities of fiber in recovered fiber. It's not all created equal. We do have some mills that are 100% recovered fiber. But in that mix, we have some flexibility. What we're seeing in the market is a significant decline in generation. That's been reported. We see it upwards of maybe 20%-plus, and you can understand why. It's coming from consumer activity. I think some generation from the consumers has been hurt because of the recycling infrastructure and keeping all that running that's probably temporary, and then a lot of businesses that have been closed that aren't generating recovered fiber. However, that's been offset a bit by the grocery channel, which is one of the cleanest sources of recovered fiber. So -- but that's about the only area that's had an increase in generation. So -- and then you've got the other part we often forget about, is 20% to 30% of the U.S. recovered fiber begins its life in another country and it's an imported box. And so as you think about retail being hurt, some of those imports aren't happening. So that fiber is never making it here to even be recovered. So for IP, we are fortunate. We have a flexible system. Our mix, because of the kind of containerboard we make and the fact that we use most of it ourselves, we are heavily weighted toward the high end of the recovered fiber market, which is coming out of grocery stores and actual box plant clippings where we recycle the cutout waste from all the die cuts and all of those things from our own box plant back to our mills. Those are the 2 highest-quality sources typically of recovered fiber. So we're very well situated in a kind of volatile OCC environment. It's hard to tell where it goes, but I think it's basic supply and demand. If we have less generation, you're going to have less supply. And there's no inventory to really speak of in an OCC system. It moves pretty quickly through the supply chain.

Great. I'm going to ask one more before I transition over to the audience Q&A, and we've got a couple of questions come in. If anybody has some questions they'd like to get in, please send them now as well. But before I turn it over, I just wanted to talk about some of the recent actions you've taken to shore up the balance sheet. We're sort of in a period where -- or maybe we're coming out of it, but hopefully -- but investors are very concerned around balance sheet strength, liquidity, the credit markets, access to capital. Maybe you could just talk about some of the actions that you've taken recently to improve the near-term cash flow. I'm thinking about some of the CapEx and OpEx savings and some of the things around the CARES Act that you've been able to take advantage of. Maybe you can just kind of quantify some of those things for the folks on the line.

So during our earnings call, our CFO, Tim Nicholls, walked through the actions we've already taken. As you mentioned, we've reduced our CapEx to a reduced target of several hundred million dollars. And we look at that as -- fact is, our asset base is largely in good shape across the company, mills and box plants. And we don't look at it as a permanent cancellation of repair jobs and cost reduction. We look at it as a timing issue, in many cases, that if we don't tie up the cash in an uncertain period, because we're not 100% sure what capacity needs we'll have, that's a good, prudent thing to do right now, to hold the cash. And if we need the capacity and the capability later, we can then begin to do those projects. On the CARES Act, I think that was in the $120 million deferred tax range. The operating expenses, we, again, have the ability to look at our overall asset quality, and it's a plant by plant. And actually, it's a unit operation inside of a plant. So it could be the pulp mill is in great shape, and the paper mill needs this money because of a chronic issue, and we'll make that decision at that level of granularity. But we can adjust the timing of some of these operating expenses. A lot of those expenses occur during annual outages. We've moved some of those annual outages to the future partly because our demand was very strong in the first 4 months of the year and partly because executing an annual outage with your own employees and some outside help in crowded areas is very difficult to do while following all of the health protocols. So we're being smart about that and not trying to take jobs and tackle things that aren't really wise to do during this period of time. So the reason behind all of that is we've always said in the company, and nothing has changed on this, is it's important for International Paper to have an investment-grade credit rating and a strong dividend. And so what we're doing as a leadership team is trying to figure out, as we had input from the market, the best approach to pull what levers in what order to try to have that as our outcome. So we have strong balance sheet, investment-grade credit, a strong dividend that our shareholders appreciate as part of who we are and a company that's ready and poised to take advantage of the economic recovery in whatever shape it's in because I think it'll be different shapes by end use segments and that we will have made good decisions through the crisis so that we're best positioned after the crisis. And that's what I meant in my opening remarks, that we're balancing short term, keeping our employees safe, taking care of customers as a safe workplace. Safe employees is the best way we can protect our investors, because that's how we're going to have the best cash position, at the same time being ready to take advantage of the opportunities that are available in the market so that our facilities are ready, our employees are healthy and we're ready to go when demand improves over time.

And just to follow up on that, a few of your peers have had to recently cut their dividend to preserve cash. You talked about just now the dividend is kind of part of who you are. But given the uncertainty and the crisis, just wondering how you're thinking about the dividend versus your liquidity needs.

Well, we just confirmed at our Board meeting the dividend for the second quarter. And again, given the levers that we pulled and that are on the slide in our earnings call deck -- and if anybody on the call -- wasn't on our call and you want to look at that, there was a good slide in our earnings deck that detailed some of the data, and, of course, our CFO entered a lot of numbers in the transcript. We feel like the levers we pulled with what we see are the right things to do for International Paper at this time. And as I said, we value the investment-grade credit rating and the balance sheet. That's why we did so much work in the last several years on the pension side of our balance sheet. But we also value being a dividend-paying -- strong dividend-paying company, and that's our objective.

That's great. I'm going to transition over to the audience Q&A. We've had a number of questions come in. We've got a couple along the same lines. So I think there was a little bit of confusion maybe just on what you were intending to say with your comments around May. So a couple of questions just asking if you could clarify whether May was up or down on box shipment volumes for you or maybe at least kind of phrase it versus the up 1% to 2% you had talked about in April.

So what I had said -- or what I meant to say, maybe I didn't say it. What I meant to say was from our earnings call comments, we talked about the second quarter looking like it was going to decelerate in box demand relative to the elevated first quarter. We made a comment about April, given it was the 30th of April, being at about 2%. It wasn't a shipment number. We gave a cut-off number because we didn't have the shipment numbers at that date. And we said, for the balance of the second quarter, we see a deceleration just based on what we see at that point. And what I said earlier in this conference was that has played out about like we thought it would, with the exception of in the last several days, things have become a little bit stronger, a little more positive in the last several days. So it could be -- we'll see, but it could be related to what we talked about, Brian, and that is the opening of some of the economies and the restaurant, for example, the foodservice supply chain. And we'll have more visibility to that as we proceed through May. In most cases, this has only been going on for about a week, these openings.

Got it. And then on capital allocation, I had a question come in around the level of CapEx and how sustainable that is. You cut it -- I guess, a couple of different signs. Well, I guess coming into the year, I think it was lower than a lot of people expected, and then you were able to find some savings beyond that recently. So a little bit of a lower number than you've been at historically. Just wondering how investors should think about that level going forward, if some of the projects or necessary spending this year are just being pushed out to the right so there'll be kind of extended catch-up period next year or the year after. And maybe just in general, kind of how investors should think about CapEx as a percentage of sales or volume or however you want to phrase it.

I think a good way to think about it is we have typically had about $1.4 billion per year of CapEx over the last several years and definitely since I've been the CEO. A portion of that has been strategic projects, mostly in our containerboard mill system but also in our box plant system, and an occasional project in our cellulose fibers business, but that's a relatively new business for us. What we said when we gave 2020 capital outlook at $1 billion versus the typical $1.3 billion, $1.4 billion was that in 2020 and probably for the foreseeable future, we don't have any of these large Riverdale conversion, Madrid mill type of projects on our radar screen. We have the assets we need. We have the capacity we need. We have the quality we need. We do need to improve and continue to improve our converting operations, but those are typically much smaller investments than when you do large mill-oriented projects. So without those big single projects, and we've had 1 or 2 for every year since 2014, we thought that the capital level we could sustain was closer to the $1 billion, $1.2 billion range. And that depends on the market demand and depends on our ability to surface cost reduction projects. The base maintenance level that we're talking about for this year, where we took $300 million to $400 million off of that $1 billion, that's not a sustainable level to run the company forever. Because if we did that, we would end up giving back the cash savings in unreliable operations. It may take a couple of years to show up, but it will happen. It's pretty predictable. It's a direct correlation to having the kinds of asset quality, reliability and all the metrics we look at and the cash flows we've enjoyed from operating reliably when we've had demand. So $1.4 billion, $1.5 billion has been -- $1.4 billion has been that average. $1 billion was the target for 2020. With the COVID-19, we've taken that down $300 million to $400 million. But I think investors can think about International Paper being in that range that I talked about. Without a big strategic project, we should be below that $1.4 billion a year in capital.

I think we've got about time for 1, maybe 2 more questions, and then we've got about 1 or 2 more on the audience Q&A. So I'm going to just go with them. A question on the impact of the OCC prices and what you can do to kind of offset that. We've seen in prior cycles the industry has tried to maintain margins by taking price actions to try and offset the run-up in input costs. Already this cycle, we've seen in the boxboard grade, some of the recycled boxboard grades, some folks come out with price increases. So I guess -- the question, I guess, just reading it, is can you -- do you think the industry would be able to try and offset higher OCC costs through price increases given the comments around demand potentially decelerating some into May and April from the elevated March levels?

So Brian, as you know, we never comment on forward pricing actions or speculation. I'll just say, though, that the way we think about pricing of our products is really a discussion between International Paper and our customers. And as we've said many, many times, it's a combination of the supply environment, the demand environment and the cost environment, all of those together and not one item in the cost environment, the entire cost environment. So that's how we continue to look at that. But I wouldn't make any comments about what we might do or might be able to do in the future about pricing.

Yes. Thought as much. I just had to try. So last one is just around the equity investments you've got. You've got the equity investment with Graphic Packaging. You have the partnership with Ilim. Both of those seem to have been going well. But with the Graphic stake, it looks like you've already moved to kind of monetize that. Ilim, though, seems like more of a strategic, longer-term investment. But maybe just from your perspective, can you talk about what each of those investments sort of brings to the table and if maybe the Graphic Packaging partnership might be one of those opportunities to bring a little bit more cash flow on to the balance sheet, a little bit more actual cash on to the balance sheet to help pad the cash flow during the crisis here?

So on Graphic, it's been a great partnership, and it's been a good investment for International Paper. We view it as a very smart way for us to help our Consumer Packaging business reach its full potential, and that's happening under Graphic's management and Graphic's strategy. As an investor in that, and that's what we are, we've enjoyed some of those benefits. As you know, and as we said in the fourth quarter earnings call, so the beginning of this year, when we reported the first monetization, we used the term by doing this first tranche of monetization, this puts us on a monetization path. That path will be evaluated on a number of different merits, including the balance sheet of the company. At that point, we weren't talking about COVID-19 in January of this year. The other thing we said was that the -- after evaluating the role that Consumer Packaging could or should play in International Paper, we did not feel strategically that we needed to add to our position in Consumer Packaging in the form of more of the Graphic investment. So that was part of what we said when we made the deal with Graphic, is that we were going to evaluate what role, if any, Consumer Packaging plays in International Paper's long-term strategy, and we've had some time to do that. So again, it's worked out well for us. The business is doing really well. And we, in the first tranche, enjoyed a return on that investment, and we're going to continue to evaluate that over time. But it's clearly a source of cash in these times. Every source of cash we have to bring in is being evaluated, and every outflow of cash is being evaluated so that we put the 2 together in the best possible way for the company.

Okay. We're out of time. I appreciate you making the time to join us today and writing all the comments. Great to hear you're doing well and staying safe. Everyone on the line, thanks again for your questions and participation. I hope everyone has a great rest of the day and enjoy the conference. Thanks, guys.

Thank you, Brian. Thanks, everyone.