International Paper Company (IP) Earnings Call Transcript & Summary

All right, guys. I'm Phil Ng, Jefferies Paper and Packaging analyst. Bright and early to kick things off. We're delighted to have the International Paper Company team with us. We've got Andy Silvernail, but also in the audience, we got Lance, CFO, Mandy and Josh on the IR side of things. Well, Andy, it's a crazy world out there. It would be helpful to just kind of kick things off here what you -- let us know what you're seeing. .

Yes. Well, thank you. I think this is the third time we've been back since I'm CEO of IP, which goes fast. So thank you. I think this is a great conference. I guess I'd start off with a few things. One, just kind of talking about just a little bit about the macro, which we are all bathed in every single day, but more importantly, the goal of where we're headed and very much so kind of what we're doing to control our own destiny in this kind of crazy world. So obviously, the world that we're living in is sitting, I have to think of a few things. One is relative to the forces of trade tariffs and conflict on both the demand side and inflation side, we all know those challenges that are out there and they are undeniable. And what it does is it sets the context for how you can compete. And that means really the most important thing is whatever a given period of time when the macro gets distorted for whatever reason. And throughout my career, the way I have dealt with that is you grab onto those things that you can absolutely control and how do you drive value and how do you drive competitive advantage and how do you drive a better position over time relative to that. And we don't know what's going to happen relative to the business. Obviously, in our world, as we kind of see that lower end consumer struggling, that's an issue relative to overall packaging demand. And then on the inflationary side, energy, obviously, is the biggest piece. We're most exposed in Europe when it comes to that. We produce 70% of our own energy in the U.S., although we do have exposure to diesel, then obviously with diesel where it is, the number is about $95 million per dollar of a gallon of diesel, if you kind of think about that in terms of the impact. So the inflationary pressures are there. Obviously, pricing has moved to deal with the vast majority that -- what we've seen in the last 18 months or so is really a balancing of inflation being covered by price. And so the incremental margin that you'd like to see from that has really been pushed into 2027 as our efforts to drive down our cost structure, which have been incredibly aggressive have offset an awful lot of that. And so we have obviously seen over the last couple of years pretty substantial incremental margin improvement on a dollar basis, and on a rate basis. And we expect to see that as we move into the third and the fourth quarter and very much so into next year. So really grabbing onto those controllables. The first around that is really just the absolute cost structure. So I think many of you who know International Paper well, in the last 2 years, we've taken out an enormous number of latent assets of unproductive assets. We've taken those closures out. We've reinvested very aggressively back into our mill and our converting systems to drive productivity, and we're certainly seeing the gains in that and we'll continue to do that. Our belief is that winning is really comes down to 3 parts. The first one is having that best cost position. And so driving the best cost position, which doesn't mean a low price position absolutely does not mean that. What it means is our ability to invest at any time in the cycle. So any time to drive investment back into the business to continue to lower that cost position. And frankly, to reinvest back into the front end of the business, what we call the customer experience, so how they experience us in terms of reliability, quality, service, innovation, as you see what customers care about, those things are not only table stakes, they really drive the willingness to pay and switching costs. And so a huge investment has gone back into the business around that, and we've seen very substantial moves in terms of where we stand in customer satisfaction rankings. And we've moved very, very nicely as we've done that in North America. And then on the relative market share side, it's important for us to build density in the markets that we deeply care about. And those are local markets kind of by MSA per se and in terms of the overall network strategy on converting and in our mill systems in North America. So very happy with the progress there that we're driving in the face of that tough macro. And then in Europe, right, this is really all about 2 things right now. The first one is the restructuring that's happening in Europe. So you've seen the information. We're going to close upwards of 40 facilities in total and about 4,000 people will exit the organization here since the start of that, which is a very aggressive restructuring in Europe, and I think absolutely necessary. And that -- and while anyone who's been through that knows that those things don't go without their bumps, it's gone very well, and we're getting the cost out of the system that we need to -- and that will be very important for the long-term value creation of that company that we're going to spin out here over the next handful of months. And so we're excited about that spend that is on track. Really, in terms of the normal milestones and pathways to that process, they're moving along very well. We will certainly be within that 12- to 15-month time frame that we talked about in the past and no real major updates around that, except the process of moving forward. And you'll see that with Tim and Vincent are here, the future CEO and CFO, they're here presenting at the conference to socialize that even more, so they're here doing that. So hopefully, that gives some confidence that this process is moving forward as we had hoped. So the last thing I'll leave you with before I turn it to Phil is what will become. And the goal is to become for National paper to be the largest scaled most present player in the North American market for packaging for paper-based packaging. And that's a great place to be. We like that business, the noise that has been around the business in terms of restructuring, in terms of asset sales, that will come to a close, we will start really driving the business on a normalized basis around those 3 pillars of strategy, driving that cost position via productivity, reinvesting back into the front end of the business around organic growth. and really around building relative market share in those markets that we care about. So we're excited to get there. It's been a long journey and a fast journey, and we're very proud of what we've done. And so with that, Phil, I'll turn it to you.

Greg. I think it's pretty well documented in terms of the investments you've made on footprint, closing high-cost capacity. But on the commercial side, at least the dinner we post with you last night was an area that you talked about you're making investments and how you're trying to further realign incentive comps to enforce proper behavior. Can you expand on that a little bit? And what you guys have done thus far, some of the opportunities going forward and how you want to rejigger incentive comp even more?

Yes. So when I joined the business, my observation was that we very much had a sales team that was kind of the classic gatherers, not hunters. That's the way I would put that. In terms of incentive comp, how we had built people into those organizations, the tools that they had were really around trying to sustain or maintain they weren't about profitable growth going forward. So a few things that we've changed pretty aggressively. Incentive compensation has moved from being a very heavily guaranteed model to a very heavily weighted incentive-based model. That's a very important change. We've changed out a huge number of our sales force and added significantly to that sales force to the tune of about 40%. And we have started to give them tools that they didn't necessarily have. Nothing that's groundbreaking in our world. But in terms of tools around discipline around pipelining and pricing and understanding that market segmentation. In 80/20, the methodology plays a very important role in that segmentation and understanding how you compensate and how you drive into the business. And we'll continue to do that. I think that modernization, certainly the utilization of data tools -- AI-driven data tools are incredibly important on the commercial side of the business, from pricing to design, to configurations to demand planning, you name that to support -- there are incredible tools that we're investing in that are certainly moving that forward. So I feel really good about that. And the important part there, Phil, is that over the long term, right, we know that the business we understand kind of what the slope of the line in terms of volume growth is going to be. And the variables are going to be our ability to take market share and our ability to capture price as tightly as we possibly can. So those are really the investments that we're making on the front end.

Let's focus on some, short-term stuff and I promise, we'll drill back on bigger picture longer-term thoughts. But certainly, from a macro standpoint, the headlines still pretty choppy, rates moving higher, oil prices, diesel prices. Curious to hear what you're seeing out there from a demand standpoint. I know you reined in your outlook in terms of industry trends last quarter. How are trends tracked July, August, whether it's the North American market or Europe?

Yes. So if you -- I mean, obviously, all the news that we all read and see and we dig into around consumer sentiment in the U.S. and Europe have been hit very hard the last 2 years relative to trade, to inflation, to the cost of energy. We've all seen that news. And in our estimation, over 2.5 years, it's cost about 5 points of aggregate demand. That's my point of view on that. And I think demand will be muted going into '27 and throughout 2017, assuming that we don't get a major relief from some of these pressures. And so if you just kind of think of it in the broad scale of the K-shaped economy that we all talk about, that bottom of that K is being squeezed, right? They're being squeezed in terms of their available spending. And they're having to make life choices that the people that I grew up with in a small town in Maine went back to summer and there have been a very different conversation and the conversations that we're having in this room around gas in my truck, buy a shirt. Those aren't conversations that this group has. But that is what most of those of the conversations most people have. And so we are seeing that the demand. And so what I would say is it's steady, but it's soft, right? It's softer in Europe than it is in the U.S. So we have to be mindful of that. And that is why we've been so aggressive around cost structure, right? So the ability to take that out to accelerate that. And so I feel like we've gotten the right balance there, but that is a wildcard as I kind of look forward. Our expectation is that the balance of this year is kind of flattish in North America. I think people saw the year consumer spending numbers that came out here in July, and they were pretty weak around retail spending and things like that. And we saw that certainly in our demand patterns. And so we expect it to be kind of squishy until we get some relief from some of these external forces. So that just comes back again and again to take take control of what you can control. And that's really around the cost structure, our ability to take market share and our ability to get very efficient with the use of capital.

Got you, but this doesn't sound too different from what you kind of outlooked post 2Q or you've seen a downtrap in the activity? .

Yes, there are 2 things. So the general answer is, yes, it's very consistent. The 2 places that I'd say are net negatives are the consumer spending numbers that we're seeing out of Europe, right, that's negative. And then obviously, what we've seen in the world of fruits and vegetables coming out of the West Coast. Those are things that are going to be -- on a trend basis, they'll look negative. There's no doubt about it. But I think from the perspective of the long-term trend, I don't know that they've changed that very much.

Okay. Well, in North America, at least, while demand feels pretty squishy. But as you pointed out, steady, supply still remains pretty tight from what I understand, specially with inhaled down, but it's up and running now. But help us kind of think through what you're seeing in the marketplace right now in North America and how you kind of see that supply dynamic playing out the rest of the year? .

Yes. So the market is tight. We've gone from, as you know, from being very long in terms of our paper position 2, 2.5 years ago, to being modestly short in our paper position because of the capacity. The high cost basically under costly capital assets that we had. And so we've changed that dynamic for ourselves pretty significantly, and obviously, given our footprint, it's impacted the industry. And so it is tight, and I expect it will be tight. And I think that's a good thing because I think the industry -- each company on their own, having the discipline to make money is very important. And I'm not sure that the company has had that discipline in the past. And I think that's a good thing across the board. And so from our perspective, what you should expect to see from us on an ongoing basis is being really around a pretty tight range around being long and short paper. I don't see that -- I don't see us being widely on one end or the other into the future. I really think that, that balance is important. I think it's what drives really good discipline, operating discipline in the company. I think when you have excess capacity, it drives an inherent. I hate to use the term, it's kind of aggressive, but laziness, that isn't good. And so having constraints and drives innovation, it drives productivity. And in this next phase, post separation, one of the most important things is going to be our ability to drive year-in and year-out productivity in this business, the ability to drive net productivity in terms of human capital and in terms of assets. That's going to be very important in the overall equation. And so I like where we are in terms of getting the asset base to the point where that constraint is natural and it's driving that. And then the investments that we've been making are starting to really layer in now. So -- if you recall, a couple of years ago, we announced a major change in our capital philosophy, where we effectively doubled the overall capital spending in North America. And it's more than just doubled the spending because it's on fewer assets. So the dollars are twice as much, but the assets are fewer. So the dollars per asset has actually gone up substantially. Some of that is eliminating a whole bunch of kind of big holes that we dug over time in terms of poor assets, we've exited those assets, whether they're mills or their box plants. So those -- that giant sucking sound towards money that didn't drive a return. We've closed that off, which is great. And we've made reinvestments back into places like Mansfield, like Riverdale, buying NORPAC, the acquisition of the Dover box plant. All of those things are allowing us to move capital from high cost, low return assets and segments of the market to high return, much lower-cost segments of the market that we really like. So we've seen that asset shift. But really importantly, what you will see from International Paper is incredible asset discipline and investment discipline. You're going to see that. We are going to push our cost curve constantly to the right where we're moving out of high-cost assets and into lower-cost assets, and that drives that best cost position, which allows us to reinvest on the front end of the business.

That's a perfect segue, Andy, that was my next question. That strategy makes perfect sense, medium, longer term, but it's been choppy, right, outside the macro, the tariffs, the war and all this inflation. As you take out that cost out and ramp up new capacity, you don't necessarily get that tailwind from investments, right? So it's been really hard to forecast model and it's just been noisy. When we exit -- I believe a lot of the start-up costs you're going to incur this year. Kind of help us think through as you position yourselves for 2027, will a lot of the pain be in '26. And could you start seeing some points on the board with these investments you made that you highlighted?

Wel, I think the bottom line is we're seeing big points on the board already. The issue is exactly what you pointed out, Phil, which is this macro noise around demand and inflation. At the end of the day, if you really kind of do the math of it, inflation and pricing have effectively offset themselves over the last 2 years, right? So there's kind of no movement. And so you look at the $700 million move in profitability and EBITDA in North America, that's effectively all cost out. right? If you look at those numbers, when you balance off the inflation. So I feel really good about that movement there. How things lend. So we've gone through kind of a really, really aggressive set of 2 years of asset sales, asset closures, reinvestment. To your point, the reinvestment is just starting to layer in now, right? So whether I'll give you an example. I was out in Phoenix here earlier this year. They're putting in a new converter this year, right? So that's a business that, that in and of itself is going to radically change the productivity profile and the responsiveness profile of that asset, that business in that region, which is an important region. And that's 1 of 80 examples across the company. So if you look across our fleet of facilities, 80 different facilities are going to get some kind of major asset investment or has been over the last 2 years and will into the future. So it's a major layering, and we're just starting to see the impacts of that now. So what you'll experience is -- and I think, hopefully, investors will like this a lot. We're going to see the volatility of stuff that we interact and we control. That amount of change is just going to radically slow down, right, because asset sales and asset closures and things like that. Those big things are coming to an end. And so as we become a singular North American packaging entity, my goal is to take this variability out. right? I can't take the market variability out, but I certainly can take our variability out. And because of our size, we can then influence the market variability. And so I think those are really important things that are going to happen here as we go into '27 post separation.

Okay. All right, looking forward to 2027, cleaner year, hopefully. In terms of inflation, I mean, you kind of highlighted earlier, Andy, energy prices in Europe, diesel prices in the U.S. I think your framework you guys gave from a guidance standpoint assume margins would improve in the fourth quarter with that price cost dynamic. I mean, diesel prices have shot up. Is that still a good framework in terms of things that you could control today? .

Yes. I really like -- if you look at North America, even with the volatility, I really like how our execution is playing out in terms of our ability to get that cost out, deal with the volatility. Again, in the U.S., our exposure to the energy volatility that we're all experiencing is really around diesel. And how that factors into transportation. So I think Lance, what you quoted was $1 diesel price is about $95 million of headwind or tailwind on an annualized basis, if it goes one way or the other. So how much is diesel up in the last 6 months, $2, somewhere in that range. So you're talking $150 million, $200 million of headwind just in diesel in that. But that being said, that's pretty isolated because in the U.S., we make 70% of our own power. And most of -- the rest of it comes from natural gas. And so in terms of energy inflation in and of itself in North America, it's really the exposure to diesel. I think that's a fair way to put that. Other parts of inflation are still there though, right? So we've seen what's happened to OCC and how that's moved. And obviously, we all know the variability in OCC over time. We do see that gliding down some now, which is good. But -- so that volatility and variability, it's not a small number. It can be a big number. And literally, if you look at this year alone, you're talking about, what, $400 million, $500 million swing in this year alone. And so last night at dinner, I was asked what I thought the exposure was into 2027 around inflation. I said, well, first of all, you got to pick your pieces. But if I pick the bookends, I can see $400 million on one way or the other depending upon the -- how dramatic you want to pick your inflation mixes. And then you think about what will happen to price kind of from there. Europe is a little different, right? So there's a lot less volatility in the U.S. Europe is different. It is different because you have a lot more energy volatility, right, the natural gas cost and the volatility of natural gas has been higher. It's really moved aggressively in the last month or so. And that's just kind of a reality. And so you have the volatility of the energy side that we have to push against. And pricing, as you have seen, has been moving very positively in the market. That's a good thing, but the lag time is longer. It takes longer from moving from paper pricing to how it hits box pricing in Europe. We very much expect to see that start to play through in the fourth quarter on into next year. So those are very positive things. So that's some tailwind but you definitely have the headwind of energy volatility and how that's impacting consumer spending. So more volatility in Europe, which means we're going even more aggressive around cost and the U.S., some volatility, but we really like how things are moving along in terms of our ability to execute.

And that $400 million to $500 million variability number you're talking about, Andy, is that a North America phenomenon or North American European combined? .

I'm just going to talk North America, as I think about the bookends of how you could hit the P&L. If you kind of take that midpoint, I could see $200 million on either side of that midpoint, right? So that's how I kind of think about that volatility of that midpoint. In Europe, it just honestly, it's harder to call because of the volatility of energy prices and on the consumer side. And so the focus in Europe really is basically, it's a redo of what we've done in the U.S., which is get the assets to the right place or get the right kind of assets and the right kind of cost position. Some of you may have seen, we announced last week we're taking down a paper machine in one of our -- in Kemsley in the U.K. And so that asset structure around there is all about what assets drive attractive return on invested capital. And so getting there at the end of the day, DS Smith had really never done an integration of the acquisitions that they've done over the years, and so we're accelerating all those parts. I really like the execution, but -- you can't do that kind of execution and have it not be messy, impossible.

Inflation is unpredictable, Andy, as you kind of called out, but with a price increase in the marketplace, assuming we get some traction, is the expectation you'll see a little more of it in 2027, just given the productivity gains plus pricing? -

Well, I think if you're asking the question, is the announced pricing going to have incremental profit impact for '27, yes. right? If you're asking if I know where pricing is going to go or predict it, no. And so the way I look at it is, obviously, we have a major carryover pricing that's already been announced and published, and we'll wait and see here in September and October, what happens to the most recent price increases that were implemented on the first. But net-net, our expectation is that, that is going to have -- is going to be a major tailwind in 2027.