International Paper Company (IP) Earnings Call Transcript & Summary

Welcome back, everybody. Glad you could be here. We are honored and delighted to be hosting Mark Sutton, Chairman and Chief Executive Officer of International Paper for our fireside chat as well as a short discussion that the company has prepared. As you may know, Mark began his career in International Paper in 1984. His entire career has been with the company, started as an engineer, he's had obviously a number of senior leadership, financial and operations positions, and he joins us at a very important time for the company. So without further ado, Mark Sutton. Mark?

Thank you, George. It's really good to be here and really good to be here in person. I ran into a few people on the way to the meeting room that we hadn't seen each other in close to 2 years. So it was really good. I think everybody is relearning their engagement skills. I know we are also webcasting, so thank you, everyone, who's joining in on that. I appreciate, along with the team, your interest in International Paper. So on Slide 2, you'll see what I think you're very familiar with, the normal forward-looking statements. And obviously, we have all the GAAP and non-GAAP reconciliations on our website. So I'm going to move to Slide 3 and start my remarks. And as George said, I'll join him for some Q&A after some brief remarks. So I'd like to start really with the topic that's on everybody's mind today, and that's the situation that's unfolding in the Ukraine. Our thoughts and prayers are with the people impacted by these events, really tragic. Just an update on International Paper. We don't have any actual operations, manufacturing operations or employees in the Ukraine or in Russia. But as you know, we have a 50% JV interest in the Ilim Group, and Ilim is a Russian-based producer of pulp and paper. There's no recourse on Ilim's balance sheet debt to International Paper. And given the fluidity of the situation, which is really changing every day on a number of fronts, whether it's regulations in country, regulations outside the country, sanctions and understanding all of that is pretty fluid. Given all that backdrop, we are actively reassessing with all of the stakeholders involved our options for our investment in Ilim. So let's shift and take a closer look at International Paper going forward. We are making really good progress on our set of Building a Better IP initiatives to accelerate growth and value creation. Over the past year, we focused our portfolio around corrugated packaging. Today, we are significantly less complex as a company with a much more narrow geographic focus. We've also initiated meaningful actions to materially lower our cost structure and accelerate profitable growth, with a commitment to deliver $350 million to $400 million of incremental earnings by 2024. And our earnings catalyst, that $350 million to $400 million, is front-end loaded with significant benefits coming this year in 2022. On a prior earnings call, we outlined between $200 million and $220 million of incremental earnings showing up in 2022. And this is really coming from streamlining our operations, taking advantage of a more focused and simpler company. But also, we've been working, like a lot of industrial companies, on using data and technology to further improve our operations. And we've now got the opportunity to scale some of those initiatives across a very big manufacturing base. We significantly strengthened the company's balance sheet and financial footing over the last several years. So just in the last 2 years, we reduced debt by $4.2 billion, bringing our leverage well into the low end of our target range. Additionally, our pension, which has been an issue -- had been an issue really coming out of the recession in the 2009-2010 time frame, that risk is off the table. The pension is fully funded. So our capital allocation framework, which we talk about a lot with investors, we usually touch on it on every earnings call, of having a strong balance sheet and operating from a position of strength, financial strength. It gives us the opportunity to have all the capital allocation levers available to us at the same time through just about any type of economic environment. So those capital allocation levers, of course, are returning cash to shareholders. We actively do that with a strong dividend and thoughtful share repurchases on a regular basis, and then investing in the business. And there's opportunity in what International Paper is going forward with our Packaging business, and our smaller Cellulose Fibers business, both focused on growing markets to make good organic investments in those businesses without the need to stop, at some point in time, one of those capital allocation levers because our balance sheet isn't where it needs to be. So we feel really good about the platform that we're operating from right now. So our team is focused on delivering superior solutions to customers. We have recently announced plans to build a new corrugated plant in Eastern Pennsylvania. And we plan to further invest in our box system. You will see regular investments. And when we're ready to announce them, we will. It will be things like a new box plant where we have limited capability or capacity in a region of the United States. And it will be investments in the 200-plus factories we already have that have the room for more equipment, and then we hire the people to run it. There'll be a steady dose of investment to grow with the market. We have a focus on growth in general, but very targeted and specific in segments that we have competitive advantages in. Some of the segments that we're in really do lend themselves to a full line company that has complete geographic coverage. And while that's an advantage for us today, lacking investment, we could lose that advantage. So that's going to be our focus. I'm going to turn to Slide 4 and just review with you what we did recently on our earnings call at the end of January with our 2022 outlook. We're projecting EBITDA for the company in the range of $3.1 billion to $3.4 billion in 2022, that's about a 25% increase relative to 2021. And our outlook includes only the benefits from previously implemented price increases, or said another way, it doesn't include any benefits for future price increases that have been announced but not implemented yet. We expect a solid demand environment, and we're seeing that right now for our corrugated packaging business and for specialty pulp. Our outlook does include that $200 million to $225 million I mentioned earlier of gross benefits from our Building a Better IP initiatives. And they ramp-up throughout the year, and we'll begin reporting on those. We're optimizing our mill and box plant system from the various disruptions we had, really, starting back in the spring of 2021, we got on some unstable footing with some capacity coming offline, mainly weather-related. Demand took off, and we struggled to really regain our footing. That's behind us now. We're operating well. Our capacity is back online. Inventory levels are in a much healthier position. A lot of good things happen when you get to that point. You can optimize your supply chain again. You can reduce your shipping and distribution costs, customer service improves. I'm really proud of our team, though, for the last year. With a lot of headwinds in our supply chain and in the external supply chain, we took care of our customers. I'm frustrated that we couldn't take care of all the incremental growth that was out there. But we took care of the customers we had, and I think that will pay huge dividends going forward. We expect free cash flow to be $1.3 billion to $1.5 billion. And as a reminder, our free cash flow in 2021 included about $300 million generated by our Printing Papers business, which was part of International Paper for most of 2021. Our free cash flow outlook also includes about $100 million of cash used for executing our Building a Better IP initiatives as well as $60 million of payroll taxes related to the CARES Act. And lastly, we're targeting CapEx of about $1.1 billion. A good portion of that is for what I mentioned on the organic investments in our box business, in addition to our normal maintaining our current fleet and protecting our current cash flows. We're also excited about some high-return projects, some of which enable some of the Building a Better IP initiatives, some of which enable just pure profitable growth in our box system. So we've got a good suite of projects, good returns and a good team to execute it. I'm going to end my remarks on Slide 5 with a brief update on our Vision 2030 stewardship goals. I know most people are interested in this. A lot of people are very interested in it. I would encourage you to go to our website and spend some time there and see what we're doing in the area of people, planet and really, the impact International Paper has anywhere we do business or anywhere we interact. Our Vision 2030 goals are being integrated better than they ever have been, better than our Vision 2020 goals were, right into our business strategies and into our capital plans. So if we take a quick look back, why do I feel confident about the go-forward look? I look at what we've done since we had our 2020 goals out there. We reduced greenhouse gas emissions 21% between 2010 and 2020. And as part of our Vision 2030 goals, we're targeting an incremental reduction of 35% in Scope 1, 2 and 3 greenhouse gas emissions against our 2019 levels. We're pleased to report that in December 2021, and we put a press release out on this so our investors and our employees could see it, that our Vision 2030 targets were approved by the Science Based Target initiative for greenhouse gas emissions. And that's, I think, the gold standard of whether your target has merit or not. Looking ahead, we intend to align our annual sustainability reporting with the recommendations of the Task Force on Climate-based Financial Disclosures, or TCFD, beginning with this year's sustainability report. We also intend to start reporting our ESG performance, so the holistic ESG performance, not just the environmental piece, under the SASB framework starting again this year in 2022. We'll publish our annual global citizenship report midyear 2022. So George, with that, with those prepared remarks, I'd be happy to join you for some Q&A.

Mark, let's get your notes together. So we appreciate you touching on Ilim because that's obviously been a question you've been getting, we've been getting. And I recognize that when you say you're considering your options, whatever the phrasing was with Ilim, that's everything and at the same time also suggest that there's not much more you can say at this juncture. But just given the questions that we've gotten, I have to ask the question, and answer it how you will, have there -- is there -- what is the risk perhaps that that asset might be nationalized or your stake would be if that's sort of a practical risk? And then the second question we've gotten frequently, how does what's been happening with sanctions and the like impact your ability to receive a dividend? And what's the likelihood that dividend would be paid, recognizing it gets paid out of Europe, not from Russia? So any thoughts on that would be welcome.

Yes. So the reason I used the word reassessing our options is just because everything you said is the fluidity I was talking about. So I really don't have anything else to report on that. We made a comment on the dividend piece during our earnings call. Again, you mentioned it's paid out of Europe, but things are moving really fast out there. So when you think about our stakeholders, we have a number of them, investors in our company. We have business partners in Ilim. We have our Board of Directors. We have our employees. And all of that factors into -- but a couple of sort of true norths, International Paper is not going to do anything, not even close that gets us crossways with any sanctions. And assessing how we make sure that happens, while we are assessing is job 1 right now. Because you have to work with the U.S. government, you have to work and make sure you understand whether or not you cross any of those. And so that's job 1. We don't operate the company, we're an investor in the company, but we do have an influence through the Board structure. So when we have more to say, and we will, we'll say it.

Thank you, Mark. We appreciate that. You mentioned that demand has been pretty solid in the first quarter. Can you go beyond that in terms of what that might mean sequentially year-on-year, however you'd like to handle it?

So George, I mean, that's the question everyone has, is what happened? And it's not just in boxes, it's in -- all of our customers are talking about their business, whether it's grocery retail or whether it's just of anything else that uses a box. How much of '20 and '21 was pull forward? And how much is sticky with the way consumers actually buy now? And then there's always that variable, are we going to do things differently in the U.S. because of all the supply chain fractures that were exposed. If you put all that together, we do some internal work. We use some really reputable outside sources of leading indicators for demand. We see, definitely, there was a pull forward. We see an elevated level. And off of that level, as we look out -- '22 may not be normal. But if you look out past '22, going to '23, '24, we see a box growth rate in the 1% to 2%, probably closer to 2%, off of that higher level. I don't think we find any evidence of retreat. So a pull-forward and a change in behavior and then a 1% to 2% growth. One thing I can say about that number is it's wrong. Anybody who tries to...

Join the back of the line.

But, honestly, we do do some analytical work to get to that, and then you have to factor in the qualitative piece about what we thought we knew before that we didn't know, i.e., we didn't know that a pandemic was going to come, and that it was going to change buying patterns. There's a lot of other things that could lend itself to box demand that could push that number higher, like the sustainability value proposition for fiber-based packaging and the debate between plastics and renewables. We think most of that leans toward the positive for us in our company and our industry.

Mark, this is up there with the old, give an inch, they try to take a mile. So if this year is...

You never -- you never do.

Never me, but others might. But nonetheless, if there was a bit of a pull forward, would it be fair to say that this year is a year of maybe stabilization in the box business and then we grow from there? Is that kind of the right take?

It could be. So far, we're not seeing that. We're still seeing the growth. But I think one of the things we've got to all keep our eyes on, and I know investment analysts do a much better job than we do in the companies, is this notion that, what's going to happen to the labor market. The amount of savings is unbelievable. People seem to be spending right through -- it won't last forever, probably, but right through inflationary pressures. A lot of that ends up driving box demand. Now you're going to run out of your savings at some point if inflation -- if wages don't keep up. And I think those are the variables that we watch, and I know all of you watch that.

Thank you, Mark. You mentioned that the operations are back to normal, and that's a good thing. What, if anything, are you going to be doing differently on a going forward basis? No one could have predicted Uri, so that's not on you. But will -- are there changes in the way you're going to run the mills? Were there changes perhaps in any of your production planning systems or approaches? Anything that creates an even better buffer for you down the road when the next set of circumstances arise?

I think we're more sophisticated in our understanding of not just absolute inventory levels, but the velocity of the supply chain correlated to the absolute inventory level. So at a 6-day shipment velocity from a mill to a box plant, the inventory level required is not the same as it is in a 3-day. And that changes pretty fast. We didn't have those feedback loops kind of hardwired in. For us, I mean, it kind of is the geography is a benefit. We are everywhere. The geography actually was a problem for us last year because we had 4 mills that were significantly impacted by the weather that hit Texas and the Gulf Coast. And we took 150-plus thousand tons off-line. We were ready to run. We had no energy. We had no electricity, no natural gas. We had employees who had their homes disrupted. So we ended up with a low inventory environment, then we had that, and then just recovering. So the dynamic that we did, and I've mentioned this on calls and I don't make any apologies for it, I think we did the right thing for the long term. We took care of our customers at what -- just about whatever expense it took to take care of them. So the long mills, the mills they needed board from were down. We made the board somewhere else. We spent premium freight instead of a rail. We trucked it. We kept all of those customers in product. In some cases, we're sole supplier to really big companies you all know, and you eat their food. And we did the right thing in the moment. What's frustrating for our teams is the growth in the market took off at that moment, and we weren't able to participate in all the incremental growth. We can now. So difference, learning how to operate our supply chain, not just our internal, but the distribution partners, making a little more sophisticated analysis of heading into periods and what inventories we need and then reliability. The weather is the weather, that wasn't an internal reliability issue. But the normal reliability issues that we would say is going to happen. We need to get those down because if we had less of that, the rest of the year, we'd caught up faster. And that takes people, and it takes some investment. And we cut back like a lot of companies because it was hard to get labor to do maintenance outages in 2020 in the first year of the pandemic. And some of that -- those jobs, we did not do because we couldn't do them, ended up causing us problems in the fall of '21. As an engineer, you know that's a possibility. You hope you can dodge the bullet, and sometimes you do and sometimes you don't.

Yes. And it certainly has happened elsewhere around the fiber supply chain globally.

We know how to do this. We know how to run good operations. There'll always be some headwind out there like a weather event. We're built to recover from that. I think we just piled on a couple of things in a row. And everybody's got the labor challenge. Skilled labor is retiring at a faster rate than you've ever seen. So we were filling it in from the bottom, so it takes a little longer sometimes to solve problems when you do have a problem. We'll fix all that because we know how to train people. There's just a lot of moving parts out there. But I feel really good about where we are now.

Thanks, Mark. Any questions from the audience? There's a question up front, Jim, if you just want to wait for the microphone. Could we have a microphone? Jim, why don't you relay the question and I'll relay it.

[indiscernible]

Mark, if -- repeat the question, Mark.

You want me to repeat it?

Yes.

So the question was just a brief overview with the spin-off of our paper business, Sylvamo Company. Is there any relationship between Ilim and Sylvamo, I think is your question. So when we spun off the paper business, our wholly-owned business in Russia, the Svetogorsk mill is part of Sylvamo as part of the paper business. And the only connection between Ilim and Sylvamo is just in a marketing agreement, a commercial agreement that happens in certain geographies for uncoated freesheet. But they're not a -- Sylvamo is not an investor and it's only International Paper.

[indiscernible]

You're welcome.

Thank you, Jim. A question from the audience that I got. I recognize you can't say much about forward pricing, but can you remind us what IP has normally said about the cadence progression of price increase in containerboard when they go through? So the question, you don't have to spend a lot of time on it, but just remind us. And then what also -- the question was, what will be different about this new box plant relative to kind of more recent state-of-the-art box plants for International Paper?

Well, more recent state-of-the-art box plants for International Paper is a difficult thing for me to describe because we haven't built any new ones in the U.S. in a while. Now that's a little bit of a facetious statement because we put new equipment in existing buildings. It will have the optimum type of corrugator making -- so what that means is the ability to make corrugated board with lots of different inputs, so some recycled paper, some lightweight, some heavyweight, different flutes. And where the real technology comes in is in the printing and the box-making equipment. Higher throughputs, quicker changeovers, in some cases, less labor, so we can keep our labor focused on the highest-skilled tasks. And it's not going to be one of these that I've mentioned before where we're putting in some specific e-commerce box plants, which are smaller, kind of co-located next to a fulfillment center and have only that ability to make the 12 boxes that any e-commerce customer might use. It's not one of those. This is a full-featured box plant in a region where we have a really good position. And I can tell you, the volume in the box plant is essentially committed with existing customers.

Got it. And just quickly, cadence, 6 months on pricing...

Yes. So for us, it's 6 months to maybe some dribbles into the third quarter after a price increase. And it has to do kind of an inverse relationship with the size of the customer and the level of volume, integrity in a contract. Usually, in return for that, you take a little bit longer to get the price...

Understood. Mark, can you talk -- let's switch gears to Cellulose Fibers. Can you talk about how Cellulose Fibers fits with IP strategy? And if you could quickly remind us what IP strategy is and why GCF would then fit. And then in turn, what opportunities for growth do you see with GCF? And there have been experiments, as you have heard other times in other questions from other fibers. What risk do you see to Southern pine and being dislocated here by eucalyptus and other fibers in the fluff market?

So the fit, we don't think about the fit being is Cellulose Fiber and absorbent pulp related to boxes. We think about the fit as an advantaged position in Southern softwood fiber, which is the key ingredient. And you can make multiple products. It goes back a little bit to where do we have advantage. And a big part of that in that business is the type of fiber. And so we think it fits. It positions IP. It's small relative to the rest of the company, but it's positioned to a growth market, 3-plus percent. So over time, I think it can be more significant. It's a U.S. manufacturing base, 1 mill in Canada, but it's a U.S. manufacturing base serving global customers. So it lets us take a highly competitive U.S. natural resource and address pretty much all of the markets that are out there for that product. The other fibers, and there's constant experimentation, we do some of it ourselves. The Southern softwood fiber, based on the fiber physics, is the best performing for the absorbent pulp in products like diapers. Mixing it with other things, synthetics or other fibers, always has some potential, but you do that for performance and cost. And some of the other fibers, natural fibers like in South America, are less expensive, but of course, they don't perform as well, so you have to usually blend it. There are some products that you don't need that kind of performance. And some of those fibers seem to be working okay, but that's not the markets we're in.

Understood. And continuing along the portfolio strategy and return continuum in terms of our questions. I know it's impossible to say exactly when, but I'll start with a, when do you think or what conditions would be required for Global Cellulose Fibers to be earning cost of capital regularly and then in turn, to the entity itself, International Paper, recognizing there have been changes in the portfolio mix over time? Certainly, the company has been actively trying to improve. I don't think anyone would doubt that. Return on capital has dropped a bit since 2015, anywhere from 5 points or more given our calculations. What will be most important from your vantage point in recapturing return on capital? What would be a fair return on capital increment from here over the next, call it, 3 years?

So on GCF, we're right around the corner to be in solidly at cost of capital. And we've been reporting on the commercial work we've been doing. That's the first piece. And again, we talked a bit in code on that because when we talk in public, we have everyone listening. Investors want to know but customers want to know and competitors want to know. Look at the results, look at the price spreads, look at what we described, we're trying to do. And in plain English, just getting paid for the value that those products provide and not operating it like it was operated in the past by IP and even by others. And so when we acquired Weyerhaeuser, we didn't change the commercial go-to-market strategy fast enough. We caught it in an upcycle on price in pulp. And we didn't make some of the changes we probably needed to make and understand how to make now. And we're seeing much better results. There is a cost opportunity as well. But as I've said many times publicly, some of that takes investment. And I'm not comfortable making the investment until we prove to ourselves, to investors and to the market that we can get the commercial piece right. And we are getting it right. And we'll see that business being a meaningful EBITDA contributor at a value-creating level of returns. On the broad ROIC question, I don't know what calculation you're doing on 5 points. We do publish in our investor material ROIC through that period of time. So '15, if I remember right, was about 11%. So we don't have any 5-point drops that I can think of. We have had in '20 and '21, lower -- some of that has to do with the cost impacts that we had. But definitely, ROIC for IP is going to be in the teens. And it's got the opportunity to grow because the lever and the gearing on improving the packaging business is huge. It's important for us to improve GCF, no doubt. And it has to be solidly at and then above cost of capital. But the real leverage in our company is the gearing on Industrial Packaging. When you look at the capital turnover of that business against the margins, we put them together, a very, very slight improvement in margins with a short, small boost in capital turnover and you move the return on invested capital materially. That's what's going to drive the company's ROIC.

Mark, just a quick one on supply chain, better or worse than 3 months ago? And I know it's a broad question, but just..

For us, all in, it's better. A lot of that is us being better. I'll tell you, the transportation environment, and I'm not telling you anything you don't know, but it is very challenging. It's getting better. We're hearing from our suppliers of rail and truck, they're beginning to get some labor trained and back. And it's not the same for everyone. You'll hear a different report from one of our competitors. And you really got to get down to where are you located. So if you're below south of a choke point in the rail industry and you're single serve, you have a different experience than if you happen to have a mill somewhere else. So it's that specific. It's better, but it is still hand-to-hand combat every day to make sure you've got the assets that you need to ship your products, whether it's to your own plant or through a port. Hand-to-hand combat every day to make sure that shows up.

Understood. So in summary, Ilim, you're assessing your options, and you'll keep us posted on how things go.

Absolutely. Absolutely.

Domestic corrugated seems solid, is running better. It sounds like it's maybe up so far. You see a path to improving return further, both because of the products you're making Global Cellulose Fibers and also the leverage in corrugated. Anything else I left out?

No, I just -- we talked about the margins in Industrial Packaging, and those margins are quickly going to return to above 20%, where they need to be. And then we oscillate based on inflation cost and coverage of that with product pricing. That's really the powerful leverage point for that business. We slipped below that. We understand why. But what investors need to know is those reasons are behind us. And we're operating well, we've got our assets online. Labor is stabilizing. We lost, like everybody, a lot of people during Omicron. So a lot of things are now becoming tailwinds for us. The team is excited. They're not exhausted, they're excited. They take it as a challenge. We don't do well when we miss growth like we did last year. It really eats at us. And we want to be there for our customers, and our employees are ready, so...

To a less anxious 2022. Everybody, please join me in thanking Mark Sutton and International Paper. Great presentation.