O-I Glass, Inc. (OI) Earnings Call Transcript & Summary

All right. Good morning. I'm happy to welcome Andres Lopez, CEO of O-I; and John Haudrich, CFO, O-I, here to talk and give us an update on trading conditions, and it will be followed by a Q&A session led by myself. [Operator Instructions] With those words, Andres, please feel free to make your introductory remarks and comment on the situation. Thank you.

Thank you, Lars, and the Crédit Suisse team for hosting us today. Welcome, everyone, and I'm joined by John Haudrich, our CFO. Today, I will provide an overview of O-I Glass and an update on how we are progressing with our strategy, some steps we're taking to navigate through the pandemic and recent volume trends. John will share our business outlook and key financial priorities. Following prepared remarks, we will be happy to take your questions. For those listening or who wish to later access the materials, the slide presentation we're using today is available on the company's website at o-i.com. Please review the safe harbor comments on Slide 2 and disclosure regarding our use of non-GAAP financial measures and a reconciliation to the most directly comparable GAAP measures, which can be found in the appendix. Let's move ahead to Slide 3, where we provide a high-level profile for the company. O-I is the global leader in glass packaging. We serve a high stable but steadily growing food and beverage industry. As noted on this slide, we have a balanced product portfolio, including beer, wine, food, spirits and NABs. We support more than 5,000 customers spanning 40 countries. Our customers include major multinational companies as well as emerging local customers. Our 2019 sales were about $6.2 billion, with a clear majority of our sales generated outside the U.S., supported by our network of 72 factories across 20 countries. Importantly, our customers highly value our global reach and mastery of glass. All those figures are ongoing and adjusted for the recent ANZ divestiture. O-I is a pure-play of [ own ] glass, which is the most sustainable packaging option and the only package that is infinitely recyclable. Likewise, it is the preferred substrate by most consumers given its premium characteristics. Importantly, we are set to win in the emerging green economy, given the increased focus on health, wellness, and premiumization across markets and segments. Our origins day back to 1903 when Michael Owens pioneer glass-forming machines and founded the Owens Bottle Company. Fast forward to today and O-I is again leading with innovation. We are successfully developing a new way to produce glass, which we call MAGMA, that promises to revolutionize the business model for glass. In summary, O-I is the preferred glass supplier to many of the large blue-chip brands you know and use every day. Furthermore, O-I is well positioned to revolutionize glass as the best and most sustainable packaging option for food and beverages. Turning to Slide 4. O-I is taking bold structural actions to change our business fundamentals and create value for our shareholders. While we contend with the most difficult business environment in our lifetime, we remain focused on executing our strategic plan. This includes the 3 areas of focus shown on this slide. First, we continue to make great progress with our turnaround initiatives. Much of the groundwork began in the back half of 2019, but the turnaround initiatives are proving to be the perfect platform as we navigate through the global pandemic. The improvements in cost and efficiency are here to stay. And in fact, this is the best I've seen the company perform in a long time. Encouragingly, we are gaining momentum and pursuing many opportunities for continued improvement. Second, we are revolutionizing glass. As I mentioned earlier, MAGMA is a new production process that represents the future of glass manufacturing. We employ -- when deployed, it will create a competitive advantage for glass and importantly, O-I. Overall, these attributes will benefit O-I to profitably grow at lower capital intensity, increase customer service, improve our total cost of ownership, enhance our sustainability profile and make our cost structure more variable to better respond to an ever-changing marketplace. We are developing MAGMA in 3 distinct generations, and there is a slide in the appendix with more detail. Today, the Generation 1 pilots have achieved every milestone. Our next installation is in Germany early next year. Success of that pilot will pave the way to broader Gen 1 deployments in 2022. Finally, we are optimizing our structure as we rebalance our portfolio and improve our balance sheet. Late last year, we divested our soda ash joint venture. In January, the Chapter 11 filing for Paddock was initiated as we seek a final resolution for our legacy asbestos liabilities. And at the end of July, we completed the sale of our ANZ business for a favorable price of AUD 947 million and with terms that maximize cash proceeds. We continue to advance our tactical divestiture program with more cash on the way by year-end. I strongly believe these are the right steps for O-I and customers, our employees and our investors. Furthermore, I remain highly confident in our ability to execute across these fronts and unlock significant shareholder value. If you flip ahead to Slide 5, you will see some of the steps we have taken to navigate this turbulent times. Back in March, we established our COVID response plan to focus on cash generation, mitigate the financial impact of the pandemic and maintain financial flexibility. I touched on a number of these elements earlier, but it is worth noting a couple of items. We strictly align supply with demand to avoid costly inventory growth. As we balance capacity, we optimize our network to manage fixed cost absorption and establish the right flexibility for the business recovery. As we have reached our inventory management targets, we are now running our manufacturing system to meet improving demand. Additionally, we have quickly implemented strict cost controls, which have generated significant and immediate results. Importantly, we established a new operating model for the company that simplifies the organization as well as improves decision-making and execution. We are watching capital like a hock, and we reoriented our capital allocation priorities to focus on debt reduction. Moving ahead to Slide 6, I will share additional color on 2020 demand trends. The chart provides 2 sets of information. On the left, you will see O-I's recent shipment trends. On the right, we have shared retail purchase trends for key markets and categories for glass. Let me share some thoughts starting with O-I. While our volumes were stable for most of the first quarter, the pandemic sharply impacted orders in April and May. This was subsequently followed by a strong recovery in June that carried through the present. We are encouraged that quarter-to-date through August, our sales volumes are up about 1% compared to prior year. Let's shift to the retail patterns on the right. As you can clearly see, retail sales have increased dramatically since the pandemic. And while they remain consistently higher, they have moderated the last few months and are running up between 5% and 25% depending on category. This makes sense considering the sharp fell-off in demand at bars and restaurants, followed by a gradual reopening. Bottom line, we believe that a strong retail activity is generally offsetting the lost sales from bars and restaurants with consumer consumption trends balanced overall. While consumption was relatively stable, our shipments and production levels have been quite volatile. Going forward, we believe glass demand and underlying consumption patterns are on a path to converge. It is important to note that despite 2020 volumes being down from market disruption, we are confident our glass volumes will return on eventually, let's say, prepandemic levels, although it is quite likely that mix could look a bit different. Let me turn the presentation over to John. John?

Thanks, Andres, and good morning, everyone. I'm now on Slide 7. Given the pandemic, we are currently providing guidance on sales volume, which has been normalized for the divestiture of ANZ effective July 31. We will consider reinstating earnings guidance in the future when markets and public health conditions stabilize. Looking at the third quarter, shipments were up about 1% through August, as Andres mentioned. This is a bit better than we originally anticipated. As a result, we now expect third quarter sales volume will be flat to slightly up compared to last year. This is a modest improvement compared to our previous guidance. Given the inventory adjustments that Andres mentioned, third quarter production should be down about 7% to 10% compared to last year. Importantly, our sales -- our supply rebalancing is complete, and production is now aligned with improving demand. Looking at the full year, we continue to expect sales volumes will be down between 4% and 7% compared to the prior year. On an encouraging note, shipments should be towards the favorable half of that range, given improved demand trends. Let's shift to Slide 8 and discuss capital allocation. We are operating under a set of specific capital allocation principles amid the pandemic. Let me review these principles and the progress we have been making through midyear. First, we are squarely focused on maximizing free cash flow. To support this, we are aligning supply with demand and limiting CapEx to normal maintenance, investments as well as MAGMA. Likewise, the Paddock Chapter 11 process has suspended any asbestos-related payments. Our second quarter free cash flow was $112 million despite this period often being a seasonal use of cash for the business. As expected, favorable cash flow trends continued into the third quarter. As noted on the slide, the ANZ divestiture will affect our reported free cash flow this year. We will provide more details after post-closing adjustments are completed. Second, we are preserving our strong liquidity. Our committed liquidity exceeded $1.8 billion at midyear, which is well above the liquidity floor that we identified for 2020. This trend has continued, and liquidity approached nearly $2 billion at the end of August. Third, we are reducing debt. As illustrated in the chart, net debt was $5.4 billion as of midyear, which compared favorably to both the prior year period and first quarter. Our leverage ratio at midyear was 4.0 per our bank credit agreement, which was in line with the first quarter and well below our covenant limit of 5.0. The completion of the ANZ divestiture last month further enabled significant debt reduction this quarter. Additionally, we continue to advance our tactical divestiture program, and we expect to complete the sale of a few small closed plant properties by around [ Europe ]. All these actions will further improve our leverage position. We currently anticipate leverage will be around 4.5x at year-end, and we are highly confident O-I will remain in compliance with this bank covenant in 2020. Overall, we are making solid progress on our capital allocation priorities in 2020 despite the challenges of the pandemic. With that, I'll turn it back to Andres.

Thank you, John. Let me wrap this up on Slide 9. 2020 has presented many unique challenges, which we met head-on with high resilience, speed and agility, delivering on our response plan. As a result, both operating performance and cash flows are strong despite these difficulties. After a rough downturn, we have seen an equally strong rebound beginning in June and carrying forward through August, leading to an improving sales volume outlook. We continue to advance our strategy and successfully take the bold actions to change our business fundamentals. Let me reiterate what I have said in the past. We remain focused on creating long-term value. I'm confident in the steps we have taken are enabling O-I to emerge in a stronger position that will benefit the company and its stakeholders in 2021 and beyond. Thank you for your interest in O-I Glass, and now we are happy to take your questions.

All right. Why don't I kick off the questions? The recovery you've seen, clearly, to the point you're rebalancing your supply side and production clearly undershooting current demand at least. Can you give us a sense of how much the production variance versus shipments is burdening the results and how you see that playing out for the year? Because it's a big variance, of course, and not covering those fixed costs, right?

Yes. I can address that a little bit. I mean so to your point, I mean, if we're looking at sales volumes that we said on the south end of that range of 4% to 7%, so call it, 4% to 5%, that would suggest that sales volumes are going to be kind of flattish in the back half of the year compared to last year, which is a lot better than the down 8% that we saw in the first half, which was down 15% just in the second quarter alone, right? Now coming out of this is we took significant production in the second quarter down, most of it because we had to. The economies were down in places like Mexico and Andean where force curtailment, things like that. Nonetheless, we still had some rebalancing to do given that we weren't really sure what exactly was going to be the demand structure going forward and what was going to be ordered and people were all trying to figure things out. But by and large, that's -- as we mentioned, that's done now. I mean -- and we're -- our production now is aligned with demand. Now with that said, the -- we're doing very well on the cost performance, on the turnaround initiatives and things along those lines. So we are not going to see the full decremental margin of that lower production in the third quarter. In fact, more than half, maybe even 3 quarters of that impact is going to be offset by those favorable cost performance trends, okay? And so -- and then as we go into the fourth quarter, obviously, sales will be aligned with -- production will be aligned with sales, again, kind of pretty comparable to the prior year. And we'll still have some cost-performance improvement. It probably won't be the same level as we saw in the third quarter because the volume of activity is lower and especially as you get into the holiday period. So really, I mean, we're going to have an impact, but it will be much more muted than what we saw during the second quarter.

Lars, just to complement that, we've been able to manage costs by adjusting capacity in line with demand a lot faster than we've done it in the past. When we compare this time, it took us a quarter to do what it took us about a year back in the previous recession.

Got it. And to your point, you're now back in balance again. So whatever happens to demand, you can kind of balance that.

Right.

Obviously, the turnaround initiatives are quite important, right? But if you go back to 2018, you had a clear line of sight of a gradual and quite consistent 100 basis points improvement per annum. And then, of course, a lot of stuff happened in between. You still have a meaningful gap to some of your peers. What can you do incrementally to get back to kind of what we talked about in 2018 and where you want to be in vendors as peers? How should we think about that?

Yes. So the turnaround initiatives are addressing revenue and cost, and this is cost across the entire cost structure. There are pretty structural changes. And we initiated this late last year. As we got into the pandemic, we accelerated all of those efforts, which are 3 platforms. We are executing really well, Lars. I think I'm seeing this company executing at its best I have ever seen. We're very confident we're going to be able to reduce costs significantly in the organization and improve margin as a result, which is going to close the gap that you referred to. But also, there are -- there is an initiative that is solidly focused on the revenue side and the quality of the revenue, too.

And really, we're going to be -- we have been and are focusing on certain pockets where we haven't gotten those margins. So for example, in our ANZ business, those margins were lower than what we were looking for. And understanding the strategic direction of the business and our customers, that was one of the reasons we decided to exit that business. That should be destructive to margin. So -- and we're continuing to trim out and look at things. We know that another area was the North American business with a change in the beer profile. Nonetheless, the U.S. market is a good glass market. It's just a different class market it's been in the past. And now what we need to do is pivot our business and encouraging with what's going on in the backdrop of the pandemic with changes of consumer behaviors and things like more on home and people wanting more of a premium experience. That's opening up a lot more doors on opportunities that can also leverage innovation. And a lot of times, those end up being margin-enhancing opportunities.

The North America operations have improved quite significantly when compared to the situation last year, which obviously impacted margins for the total company.

For sure. Sticking with the pandemic, of course, there's a bit of stop and start, particularly in the LatAm business. It's difficult to say where we're heading, right? But I guess, Mexico were, for a while, shut down and a real issue. And where do we stand today in these markets given the -- with the pandemic?

Yes. So we -- when -- with the lockdown orders, there was a significant impact, very large impact in Mexico, Andean countries and Brazil. Now in 3 countries, Mexico, obviously, Andean and Brazil, all of them are back to a normal situation at this point in terms of level of operation. And obviously, demand is starting to pick up. So we're matching both. But we're not dealing with the situation we were dealing through April and May and here in June at this point anymore.

Yes. Lars, I would just add, I mean, it's amazing how uniform we're seeing across all of our business and the pockets of the business, how well things are generally recovering and stabilizing. And so it's encouraging.

Very good. One thing that stands out, and it's -- to be clear, it's a debate among investors, right, when we're talking sustainability. A bit of a devil fab you could hear right, but everyone regard if it's plastics, cans or paper or glass, would say they're the most sustainable pack. And of course, anything you say, an investor would say, "Well, that can't be true because someone needs to be worse than the other." So the sustainable side of glass, of course, you mentioned the natural raw material. There's no doubt, it's clean, no additives. And then the other side, you've got the CO2 footprint, which is significant, right? So how do we parse this out? How can we talk about this as the most sustainable packaging given the footprint? And of course, we can come to MAGMA, which I would argue then would probably improve that footprint, right? But any thoughts you want to give to why this is the most sustainable packaging beyond the natural raw materials, et cetera, that would be good?

Okay. So there are several dimensions of that. But let me start by saying that we just appointed a Chief Sustainability Officer, elevating sustainability in the organization. I think we're doing a lot more than is visible out there. So I think you can expect that you're going to see more of that in the near future. Now the product itself is 100% recycled, and that's ideal. Now when we look at the emissions and the impact of the products and operations and all that, MAGMA includes a significant change from a sustainability perspective. So it has a sustainability dimension. We haven't touched on that in previous meetings and communications, but it is incorporated. And we believe that is going to make a significant change in the position of glass going forward. Now everyone has claims, I think, in terms of their attributes and all that. I think in our case, we can say what we claim is there. It is available. I think glass is going to be more and more relevant. And as we continue to reposition, it's got its value in the market.

I mean just to build on that, I would add a couple of things. I mean glass doesn't really represent the type of packaging waste that you see in some products, right? I mean you don't see it floating around in the Pacific Ocean is trash, for example. So -- and also as we look forward and enabled by MAGMA but also other developments is there's opportunities around light-weighting. We have a lot of focus on that to be able to make the product lighter but still strong. And then the opportunities down the road with biofuels and other sources of energy that are much more CO2-friendly and environmentally friendly than the straight legacy type of inputs and things like that. So all of that's part of that generation and development of MAGMA, but it's -- there's many facets there to look forward to.

Yes. And we normally have a lot more access to information in the United States. When you look at recyclability of glass in Europe, it's quite high. I mean there are operations and there are countries that are over 90% of recycled content. Now in the United States, that's not the case. But our focus is to improve the system in the United States, which, obviously, they are deteriorated, not making just improve the qualities of glass when single stream was implemented. So they were working on alternatives to be able to solve that, to be able to increase the recycled containment in the United States.

All right. You have your own MAGMA, which, of course, is -- can be revolutionary, assuming that it works as we hope it does. This seems to be the general sort of platform for the European industry to develop an alternative system. I would assume that you're participating in that as well. What are the main differences between that and what MAGMA is doing?

Yes. We are participating on that. That is same type of technology, using electricity higher level than it is used today in the current furnaces. But it's the same concept. It doesn't really address the structural issues that we are addressing with MAGMA. So it is a very different solution. If successful at that point in time, we will use more electricity, and we will use less natural gas, a different combination of that, but it's exactly the same technology with the same structural construction.

Got it. You mentioned, of course, part of the margin expansion, or you called out ANZ being a not great margins, and it's going to be accretive to margins to move out of that business. You did spend quite a lot of money in there to improve that. What actually didn't happen? Why didn't the margin expand as you had expected? And then you're still the ramp of business still left in that business, which you're making glass at a loss effectively. Are those the assets you talked about some singular assets that you may divest as part of this continuous improvements or?

So let me touch on ANZ first. So we put a lot of it for over the last 2, 3 years on assets. That's really where a lot of this investment went to improve the condition of assets recurring then. That impacts margins and performance. You got to shut down the assets. You got to outsource from different places. So that's why we couldn't really see the uplift, but the asset base is in a good condition now. I think it's in the hands of somebody that can do better than we can do for the asset. Specifically, we're focused on our core markets. We believe where -- there is the largest potential for Owens-Illinois to be developed, and we're very happy with that decision.

Yes. And then on the divestiture side, we still have the tactical divestiture program outstanding, and there's about $200 million to $300 million left over the balance of this year going into next year, and that continues to advance. That's going to be a combination of things like closed plants, and we referred to those, a few closed plants. And there's a series of more that we'll be able to monetize. And I think it would be sold without having -- and we can monetize that sell, reduce debt, reduce interest without having any impact on our earnings, right, on any earnings dilution. We also have some kind of nonglass container packaging assets and businesses, kind of smaller pieces around there that may be evaluated in that regard. Kind of like what we did with the top of soda ash venture was associated with the business, but it's really not directly engaged in the business. And then, of course, we do have certain pockets here and there of assets that just aren't getting the return that we want to see, and we need to take action on those. We believe that that's really accretive, earnings accretive and margin accretive.

Got it. I just want to circle back to 1 comment you made, Andres, about the U.S. market that has changed. It's different. And you've obviously been shifting away from beer to food, I guess, to a degree. So what is really -- is there an incremental change? Are you seeing that market now stabilizing and potentially even pockets of growth? Or what is the real change for you as a company aside from making a jar as opposed to a bottle?