International Paper Company (IP) Earnings Call Transcript & Summary

Good morning. My name is Adam Josephson. I'm the paper and packaging analyst at KeyBanc Capital Markets. I am honored to be joined by Mark Sutton, Chairman and CEO of International Paper. Mark has been with the company his entire career and became CEO in late 2014. Under his watch, the company has been increasingly focusing on its domestic corrugated packaging business, having recently sold its stake in Graphic Packaging and its corrugated packaging businesses in Brazil and Turkey, along with having announced the sale of its packaging business -- excuse me, its Kwidzyn mill in Poland and the spin-off of its papers business. Mark will make brief introductory remarks, and I will ask a few questions. If you'd like to submit questions, please do so at the bottom of your screen. And I'll ask as many as I can. And with that, I will turn it over to Mark. And Mark, thank you again for joining us. It's an honor to have you here.

Thank you, Adam. It's really good to be here. And as you mentioned, I don't have any formal presentation, but I would like to make a few remarks before we head to Q&A. About 5 weeks ago, we reported our first quarter earnings. And since that time, we've had a couple of items of note I just want to touch on, and you kind of mentioned a couple of these. On May 19, we announced that we monetized the last portion of our equity stake in Graphic Packaging. We exchanged our remaining partnership units for shares in graphic packaging common stock, and we sold that upon receipt. And like the other tranches of nonoperating cash that we're forecasting in 2021, you mentioned Kwidzyn as an example. All of this nonoperating cash flow will be applied within our existing capital allocation framework. Also earlier this week, on Monday, actually, we closed on the sale of our corrugated packaging business in Turkey to the Mondi Group. And lastly, things are still on track for the spin of our paper business. We still believe that will happen in late third quarter. We're making solid progress as we get ready for the new IP post the paper spin. We're making solid progress on building a better IP to deliver $350 million to $400 million of incremental earnings as we exit 2023. We shared the initial ideas in December when we announced the paper spin. We touched on some value drivers in our first quarter call. And we'll continue to update investors as we go forward on what kind of progress we're making. We're also in the moment here kind of tactically, but pretty important, we're also continuing to see very strong box demand in our U.S. box business and in our European box business. So Adam, with that, that's the remarks I wanted to make. I'd be happy to launch into Q&A with you.

Terrific. Thanks a lot Mark. I appreciate that. So you referenced some of the sales you've recently made. And so when I add up the proceeds from those sales and what you'll receive from your timber monetization notes, you're talking about in excess of $2 billion of cash. And so one obvious question is how you intend to spend that cash. And more broadly, how you're approaching your leverage situation, in the sense that your leverage should end the year in quite good shape, and you have the opportunity to stay below your leverage target of 2.5 to 2.8x for some period of time. And so I'd like you to compare your situation today to that which existed during previous cycles and to talk about whether you intend to remain perhaps at the lower end of that range or even below the low end and how you're thinking about your leverage as perhaps distinct from how the company thought about it previously?

It's a great question. The first part, Adam, on the $2 billion or so of nonoperating cash flow from proceeds from these strategic actions. As I said in my remarks, flowing through the existing capital allocation framework, the balance sheet and debt reduction and really the way we look at it, kind of derisking the company is a big part of that. And then the dividend, share repurchases and value-creating, investments, maybe small type of M&A is the last piece of that. That $2.1 billion, along with the operating cash flow we generate in the coming quarters will compete for the right position in that capital allocation framework, with a bias toward -- as we have been through 2020, biased toward debt reduction. And as you said, taking our debt to EBITDA to the low end and maybe even below the low end of the range, and we're comfortable with that because it gives optionality. I can't remember a time in International Paper that is in any kind of recent modern history that we have had the opportunity to have all options on the table for capital allocation through a cycle. Usually, because of the way we built the company, when there was a downturn, we were deleveraging from a prior acquisition that might have happened a couple of years before. I want to see us in a position and we're getting close to that, where we have the low end of our range on debt, the opportunity to continue to grow our dividend, continue to be more strategic in share repurchases, especially if there's a downturn, and we can buy more shares at a trough environment, which we haven't been able to do in the past because of the balance sheet. And then there's opportunities for organic and inorganic investments in our packaging business primarily, mostly in the converting space. So as we think about the cash, we think about the versatility or the flexibility we want to create in the company as we go through '22, '23 and '24, that's what we're setting up for, and I really like the progress we've made and the optionality we're going to have to really be able to execute the best possible capital allocation strategy over the next few years.

Terrific. As I mentioned in my prepared remarks, you've been exiting a number of businesses, many of which happen to be outside the U.S. and so -- which begs the question, are you actively trying to reduce your geographic exposure and focus on the U.S.? Or is it more of a function of the fact that the businesses you sold just so happened to have return profiles that did not meet your criteria?

So the primary reason we made the decisions to divest what we had divested was that the businesses didn't fit with our long-term strategic objective. A part of that is not creating a level of value-creating returns, not the geography that they happen to be in. The Kwidzyn example doesn't fit that profile, which is a very profitable operation. But considering we made the decision to strategically move away to the consumer packaging and ultimately sold our last piece of the Graphic Packaging investment, Kwidzyn's future and a lot of its present is really holding boxboard for consumer packaging and just a little bit of uncoated freesheet. So that mill, that asset is an excellent asset with super talented employees, very profitable, but better in the hands of a consumer packaging company. And we thought that was the best value for the IP shareholder. So not about returns, not about geography but about business direction. The other 2 examples of the 2 corrugated packaging business, one in Turkey, one in Brazil were more about not being able to create the advantaged value-creating position that we wanted to or not willing to do it with the level of investment. And by the way, in both cases, what those businesses are missing is more integration with local containerboard. And we just decided we had higher-priority investments to make. So those were the thought processes around. Less about geography, more about performance.

Understood. In terms of box demand, domestic box demand, what -- I ask this knowing it's a difficult question to answer, but what long-term changes do you think will result from the pandemic, not only e-commerce, but also anything else such as reshoring? And relatedly, when the economy goes into its next downturn, whenever that may be, how would you expect box demand to hold up compared to previous recessions?

On the pandemic specific, the catalyst that the pandemic provided, I think the biggest impact that we can see, of course, is what everybody saw, which is probably a pull forward or a step-up in e-commerce that was material. And I think there's a level of sustainability to that, maybe not 100%, but because of how it was made up with existing e-commerce customers, ramping up their purchases and importantly, new adopters that our customers had never seen before participating in that channel, the combination of those 2 and maybe whatever they do to look at the data analytics around customer retention, there's a pretty strong confidence level in the major e-commerce players out there that we serve all of them, that there's a level of stickiness to this, and they are planning for that volume and asking us to plan for it by making more corrugated investments -- corrugated packaging investments in different locations and in different types of capability be there forever. Reshoring, I'm hesitant on that one. I hope more of it happens. But every time we have big supply chain disruptions or geopolitical issues, we talk about reshoring and then nothing happens. The one difference here for me though is that the length of time the pandemic has created an exposed supply chain risks, and I think there might be some actual action around -- whether it's in the pharmaceutical chain, light manufacturing components, that we actually say, "More of that should be closer to the end product," and we see some of that happening in the U.S. If that happens, Adam, I think it bodes well for box demand. Maybe it gets us closer to box demand recoupling with GDP, where we've largely been a full 100 basis points or so behind GDP in any given year. So jury is still out on that part. I think a lot of the e-commerce is real and here to stay.

And just related to that point, Mark, can you talk about some of the investments that your e-commerce customers have asked you to make? And just talk about what their level of demand visibility is and how that is affecting how you're planning for the next year or 2 and what investments you're thinking about making?

So on the investment level, it's all in converting. It's all in box making. And part of it's geographical investments where new distribution or fulfillment centers are actually being constructed, and we may have a gap in our production capacity, economic gap. We can ship it from anywhere, but you pay too much for logistics. So we need to be closer to where the packing actually happens. And then secondly, the business is getting so big for us that it now makes sense for us to invest in specific e-commerce box-making technology in a bigger way than we have in the past. It's different machines. It's precise machines than more traditional boxes. And so we can make more money and higher margins if we may get on the right equipment. So those are the 2, capacity, geographic capacity; and then internally to IP, making sure we're making these packages on the most profit per hour oriented capital installed. The customers have their own proprietary ways to look at their customer retention. But a theme that comes across all of the big ones that we deal with that have sophisticated data analytics. They look at things like their subscription services, for example. If a new adopter just does a bunch a one-off purchases, that's one thing. If a new adopter to e-commerce signs up for subscription services where I'm going to have something delivered every month, there's a level in their modeling that says, "Hey, this customer looks like they've committed." It's not 100% accurate, and we don't know what's inside all the black boxes, but those are some examples around where they can see loyal customer commitments that they can begin to plan on. We get from our customers an aggregate readout of that and they basically say, "Here's where -- the range of demand, we believe, we'll need you to be able to meet. And if you can meet it, it's yours." These are existing customers, and we just grow our share. And in the past, without a pandemic, just normal e-commerce trends, they've been pretty accurate in those ranges. So we believe the range and we're planning for it.

I appreciate that. Just one more on box demand before I go to another topic, which is there are some quarters during which you grow by less than the market and some people get concerned that, oh, IP is losing share, whatever the case may be. Given your share of the market, you're about 1/3 of the North American market, what do you think is a reasonable demand growth expectation for the company through the cycle and why compared to whatever the market may do?

Yes. I think what we believe is reasonable and what we would say is our absolute minimum expectation is that we grow with the market over time, maybe not in an individual quarter because there could be segment exposure and just the scale you mentioned. But over time, International Paper should be with our footprint, with our capability, with the kinds of customers we have, size, market leadership positions, both large customers and local customers, there's nothing keeping us from growing at the market level. Innovation, supply chain services, being connected to a few fast-growing customers in a few key segments should allow us to have some quarters where we -- and maybe for a full year, we're a little bit above the market. That's our objective. We have to do it quarter after quarter. We have to do it based on value, not on anything else, value creation for our customers, but that's our expectation. A year ago, pre-pandemic, we had 3 out of the 4 quarters. I think it was in '19 where we grew faster than the market and 1 quarter where we were right on top of the market. So we know we can do it. That's our objective, and that's what investors should expect that we can perform with the market and in some cases, slightly above it.

Terrific. And just one on the supply side. So there have been a number of machine conversions from graphic paper and newsprint to containerboard and they're more in the offing, along with some new recycled mills that have been built. How much more in the way of conversion do you expect in the years to come given what you see happening in the paper market? And what implications could that have for the containerboard market, obviously, whatever additional announcements there may be?

So we try inside of our company, and I'm sure probably everyone does this, but we try to map what we can find publicly around candidates, assets that we don't own that others own that fit the profile of conversion from grade A to packaging. It's a finite number, but there's a fair amount of assets at different levels of investment. So then you have to kind of put a judgment on it. Will somebody actually spend that much money to make that conversion? If it's not in a -- if it's virgin paper, for example, and it's not in a southern pine wood basket, it's a steep hill to climb to be really profitable through a cycle because of the wood cost. Then there's the greenfield you mentioned, which can be built essentially anywhere there's recovered fiber. So near some city that consumes boxes where the population consumes boxes. And for that, it's a little bit more hard -- it's hard to predict. But what we try to look at is the growth of the market, the industry players, the new entrants. And we think most of the capacity additions that have happened and that are at least visible now, announced and maybe speculated on, the market can absorb. It depends all on how fast it comes in. The way the market is structured, Adam, and you know this, the containerboard manufacturing is fairly consolidated into reasonably large assets. When they come on, they come on with a lot of production. But then it bifurcates and distributes regardless of the company ownership through thousands of box plants and then tens of thousands of box users. So it really doesn't matter if you've got a lot of excess in the first stage of the value chain, a lot of containerboard. Getting it through that more distributed network to the end user has got just some natural physics keeping you from just blowing it through there. In other words, the premise is nobody is going to buy a box that they don't need, even if you've got low-priced containerboard or a lot of containerboard. And that's more or less how things have fleshed out. So I think we believe it's manageable. There is more out there in terms of conversions, but nothing that we think can't be managed.