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

Well, welcome back, everybody. Hope you had a good break. Very glad to have O-I Glass, one of the original companies that we've had at our conference over the years back again. Here from the company are Chris Manuel, who we know from Investor Relations, our old friend, does such a great job there and with the company's strategy as well; and our other old friend, John Haudrich, who is Senior Vice President and Chief Financial Officer of the company. As you know, John's focus is on O-I's strategy execution and performance management, financial decision-making, and he heads up all the financial information, technology and strategy and integration functions at the company. John was named CFO in April of 2019. After joining O-I in 2009, we know them from containerboard as well. So he knows everything about packet there is to know. And without further ado, I give you John Haudrich, everybody. John?

Thank you, George, and a big thanks to the Bank of America team for hosting us today. Sure great to be back in person again. I'll provide a few comments this morning here, including an overview of O-I Glass, our key 2022 priorities and long-term strategy to increase shareholder value. Afterwards, we'll be more than happy to take questions as part of the fireside chat here. For all of those who are listening, but unable to see the materials on your screen and wish to review them later, they are available on our website. Please review the safe harbor comments that you see here on Slide 2 and the various disclosures that are found on both the slides and the website. On Slide 3, you'll see a high-level profile of the company. As you know, O-I is the global leader in glass packaging. We serve the highly stable and steadily growing food and beverage industry, serving over 6,000 customers across the globe. These customers highly value our dedicated service and our unparalleled production network to meet their needs across the globe. As the industry leader in innovation, we're proud to make glass, the world's most sustainable packaging solution. Likewise, it's the preferred substrate by most consumers given its premium characteristics and their increasing focus on health and wellness. Looking at Slide 4, we have laid out the key elements of our strategy to enhance stakeholder value. This is consistent with what we shared during our recent Investor Day. The combination of favorable market conditions for glass containers, O-I's ongoing transformation and the introduction of MAGMA are building the path to YES!. YES! to profitable growth. Glass is poised to benefit from mega trends such as wellness, sustainability, premiumization and at-home living. Given these trends and a revitalized commercial approach, we are investing in new capacity to enable profitable growth opportunities with our strong organic commercial pipeline. YES! to an agile and resilient company. Our transformation is well underway, and I believe recent performance demonstrates the momentum we are building. We expect significant benefit from our ongoing margin expansion initiatives. We are expanding our portfolio optimization program to realign the business portfolio, fund organic growth and improve our return on invested capital. Also, we intend to resolve legacy asbestos and pension liabilities that have hamstrung the organization for decades. Finally, YES! to a more sustainable paradigm for glass enabled by MAGMA. This new breakthrough solution provides a host of additional capabilities to build on top of our world-class heritage network. With MAGMA, we can meet the needs of evolving market and expand our business. These efforts are set to accelerate O-I's transformation through profitable growth, improve financial performance and value to all stakeholders. We are excited about the future, and we believe O-I represents a compelling investment opportunity. Moving to Slide 5. First, let me emphasize that we expect glass will benefit from key mega trends that reflect changing consumer preferences. The pandemic has only accelerated the wellness trends as consumers increasingly focus on healthy living habits. Glass is all natural and inert. It will not contaminate the product content. In fact, it's the only package that is recognized as generally safe by the U.S. FDA. Consumers want a premium experience, and our customers want to differentiate their products on the store shelf given brand proliferation in recent years. The appearance of glass containers alone can define a brand, transform the ordinary into the extraordinary and build a consumer connection unlike any other substrate. With increased urgency around climate change, consumers increasingly demand earth-friendly products. Glass is all natural, reusable, 100% recyclable. It's a great fit for the new green economy. As you can see on Slide 6, O-I is benefiting from these favorable trends, which are expected to continue in the future. On the left, we illustrate O-I's historic volume trends over the past 5 years. The chart breaks out both O-I's consolidated volume trends as well as trends, including our strategic joint ventures. Overall, our consolidated volumes were pretty stable over the 5-year period. However, our business grew about 1.5% a year on average when including the joint ventures as we intentionally aligned our business to the fast-growing premium import beer category from Mexico to the U.S. On the right, you can see Euromonitor's projected packaging growth over the next 3 years. In total, glass demand is expected to grow about 1.6% a year over this period. However, growth is expected to range between 2% and 3.5% a year in O-I's core markets and exceed the average growth rate across the overall packaging market. As you can see, glass is an attractive and growing market. I'm now on Slide 7. While markets have shifted in our favor over the past few years, we have also been hard at work transforming our company. As you can see here, we have built a simple and agile effective organization, optimized our structure and improve the cost position of our operations. This includes building the strongest commercial pipeline I've ever seen at O-I. We have achieved over $250 million of benefits from our margin expansion initiatives and announced over $1.1 billion of asset sales as we optimize our portfolio and reduce debt. Likewise, we have an agreement in principle for the resolution of legacy asbestos liabilities. As a result of these efforts, O-I is consistently delivering on its commitments over the past 8 quarters despite major market uncertainty and volatility. We have passed an important inflection point, and we are set to accelerate our transformation as we begin implementation of MAGMA to enable profitable growth. As you see on Slide 8, we have -- you can see the key benefits of MAGMA, which is O-I's new proprietary glass production system, leveraging new breakthrough technology. Our heritage network is a great fit for many of the categories we have served for decades. Given the trends that I just mentioned, health, wellness and sustainability, there is significant future opportunities in a broader array of end-use categories that tend to be more differentiated and fragmented. MAGMA is a perfect fit to expand in these categories. MAGMA is more flexible, scalable. It can be more rapidly deployed. It could be co-located and improve supply chain efficiency. It is a more cost-effective and lower capital intensity option. Likewise, MAGMA enables significant container lightweighting and will enable future use of carbon-free sources like hydrogen and biofuels. So it increases convenience and sustainability. MAGMA represents a major leap forward in how glass is produced. We expect MAGMA expansion projects will generate returns in excess of 20%. Let's turn to Page 9, building on our growing commercial pipeline, we are expanding in premium markets across premium categories with premium technology. We intend to invest up to $680 million to enable up to 6% new capacity over the next few years. As a result, we expect our sales volume will grow 1% to 2% on average over the next 3 years. Currently, we have 2 projects underway in Colombia and Canada, leveraging heritage technology. Future projects will increasingly leverage MAGMA, including up to 11 new MAGMA lines in highly oversold markets and categories. Moving to Slide 10. We are redeploying capital to fund this growth. We anticipate completing our $1.5 billion portfolio optimization program by year-end 2022, well ahead of our original goal. We have earmarked these proceeds to help reduce debt and fund the expansion projects that I just discussed. As a result, we will divest noncore assets to redeploy the proceeds to expand in attractive high-return markets and improve our return on invested capital. Importantly, this will allow our strong underlying free cash flow to support further balance sheet improvement. On Slide 11, we have laid out our key strategic objectives for 2022 that are well aligned with the strategy. As we seek to expand margins, we intend to achieve higher selling prices that will offset last year's unfavorable spread and recover the impact of 2022 in cost inflation. We will also continue our highly successful margin expansion initiatives that should yield at least an incremental $50 million of benefits. Next, we intend to profitably grow our business in premium categories in key strategic markets. We will substantially complete the expansion initiatives in Colombia and Canada this year. Future expansion will increasingly utilize our MAGMA technology. As I just mentioned, we will complete our portfolio optimization program in 2022 and intend to resolve legacy asbestos liabilities by around midyear. Further progress is expected to derisk our pension plans. We expect to complete our multigenerational MAGMA development plan over the next 3 years. In 2022, we will have our Generation 1 solution fully optimized and plan to validate the Generation 2 pilot that's currently underway. Likewise, we will continue to advance our Generation 3 solution that includes our ultra lightweighting initiative. We have also a busy agenda improving our already strong sustainability profile and changing the narrative on glass through our highly successful Glass Advocacy digital marketing campaign. On Page 12, we show the 2022 financial priorities. This year, we will focus on funding our expansion projects and further improving our balance sheet. We intend to optimize our adjusted free cash flow, which should be at least $350 million in 2022, reflecting an EBITDA conversion between 25% and 30%. I've already discussed our plans around portfolio optimization, Paddock and pension. Finally, we will further reduce our leverage. As illustrated on the right, we have recently introduced a more expanded financial leverage measure, which includes net debt like the past as well as our legacy pension and asbestos liabilities. As you can see, we have made significant progress reducing our financial leverage compared to recent years. While we will incur new debt to fund the Paddock trust, the Paddock support liability will be eliminated. We are also taking a proactive approach to manage upcoming debt maturities. For example, last week, we completed a strategic tender offer and retired $250 million of upcoming debt maturities due in 2023 and 2027. This was funded by excess cash on our balance sheet. Our cash and liquidity posture remains strong, and we may look for additional opportunities to retire debt and push off debt maturities later this year. We expect total financial leverage inclusive of legacy asbestos and pension liabilities to decline from the mid-4s last year to the high 3s by the end of 2022. This reflects strong adjusted free cash flow and proceeds on divestitures that will more than fund expansion this year. We remain on target to achieve our total financial leverage target of around 3.5x by 2024. On Page 13, we have outlined the company's business outlook. Demand for glass containers remains strong. Shipments were up more than 4% quarter-to-date through February. Likewise, the benefit of higher selling prices is more than offsetting cost inflation, and operating performance remains solid. Of course, we are deeply concerned about the situation in Ukraine and the safety of the people there. Keep in mind, we do not operate in Ukraine and essentially have no exposure to Russian customers. Currently, the company is not updating its first quarter and full year 2022 business outlook that was previously provided during our year-end earnings call. With that said, we have not experienced any operational disruption, but we'll continue to monitor the potential regional market developments closely. Let me add a few comments on sustainability. As illustrated on Page 14, we continue to improve O-I's already strong sustainability position. This improvement has been noted by the likes of analytic -- Sustainalytics and EcoVadis to name a few. Glass is the most sustainable packaging option. It is 100% recyclable, it is infinitely reusable and a perfect fit for the circular economy. Glass is all natural and inert. Even if discarded, it is never trash. As such, it's both earth and ocean friendly. Importantly, glass is locally produced and sold without reliance on a carbon-intensive global supply chain. In fact, glass is already what other packaging options aspire to be. Currently, we have many efforts underway to improve our operating efficiency and recycling rates. As I mentioned earlier, MAGMA will significantly improve our sustainability position. With MAGMA, we can reduce emissions, use a broader array of recycled content, reduce the weight of our containers, near or co-locate with our customers to reduce transportation and eventually run on renewable energy sources like hydrogen and biofuels. I believe you'll be hard-pressed to find a manufacturing company producing an already highly sustainable product with so many levers to further improve its sustainability position. Of course, sustainability isn't just about emissions. On Slide 15, you can see a set of ambitious ESG targets and invite you to review our recent sustainability report issued last year. Let me conclude with a few comments on Page 16. O-I is performing well. We are much more agile, resilient company leveraging improved capabilities. As a result, we have consistently delivered on our commitments despite a number of macro challenges and uncertainty. O-I is the market leader in innovation in ESG. We are transforming O-I and our multiyear margin expansion initiatives are gaining steam. MAGMA is advancing well and will unlock significant growth opportunities. Finally, we are resolving legacy liabilities and improving our structure. We are building a path to YES!. YES! to an agile and resilient company, YES! to a new paradigm for glass and YES! to profitable growth. As a result, I believe O-I represents an attractive investment as we accelerate our transformation. Thank you for your interest in O-I Glass. And George, more than happy to have the fireside chat.

Thank you, John. Great rundown. I guess maybe to start, you mentioned that your volumes are running up 4% through February, which is terrific. Yet you didn't update your guidance overall. So thank you and the old lesson, give an inch, take a mile. So in terms of -- that would suggest there's upward tension to your outlook. What are some of the headwinds that maybe are preventing you from raising it? Or maybe that's just not the issue at all. It's just to say it's early in the quarter, a lot happens in March and things are good, but we just chose not to update.

Yes. No, I would say that if you take a look at the performance of the business quarter-to-date, it's very, very good. As I mentioned, the sales volumes are above our original guidance range. The price over inflation is playing out just as we expected and projected. And the operating performance is very good. Obviously, 40% of our business is in Europe, and we do have the situation with -- in the Eastern Europe with Ukraine. So we just think it's prudent at this point in time to hold off on providing any further update. But as it stands right now, the business has performed very well.

Okay. Very good. And one you hit on, obviously, a question that we've been getting and that we would have as well in terms of what could happen based on what's going on in the Ukraine. And obviously, our thoughts and prayers are with those who are being affected by that most directly and probably your biggest thought will be around all your employees who are in Europe. Now O-I's strategy used to be many years ago, an Eastern European strategy. That was where the company built out its glass operations from, obviously, it's become a much larger pan-European business. What concerns do you have on how this might be able to pinwheel, recognizing it's very early and a fair answer would be, we don't know.

Right. Yes. Okay. That's a fair point. So 40% of our business, as I mentioned before, is in Europe. Of that business in Europe, 5 out of our 36 plants are in Eastern Europe, so we're in Estonia, Poland, Czech and Hungary. So yes, we do have business over there and have expanded it over time, but on a relative footprint, it's still a minority of our business over there. With that said, the 3 things that we keep our eye on right now, first and foremost, is the supply of natural gas. A good portion of natural gas, as we all know, is -- in the continent is supplied out of Russia. Right now, all the sanctions and activities are kind of worked their way around that. So there doesn't appear to be anything at this point in time to impact that. We're very confident in our procurement and our contract positions on energy. And as I mentioned before, we're confident about our ability to have positive spread relative to the overall input cost. Of course, any -- the key there is the actual transportation and transport of natural gas and whether there'd be any disruption there. At this point in time, like I said, there's nothing to signal that, but it's something we keep closely monitored. Two other things that we're really worth keeping an eye on is just overall supply chain. Some of the raw materials we get such as soda ash does come out of Turkey. It's closer to the region. We just want to make sure that those areas don't see any type of supply chain disruption. Again, so far, no problems at all.

No, that makes sense, and it's a great rundown. Based -- if you held the situation in the Ukraine constant from here, and there are no guarantees in life with anything, but just so we don't have that as an additional variable in the discussion, how comfortable are you given what you're seeing that your price cost would be positive as -- to the $50 million guidance I think you gave for this year?

Yes, consistent with our comments that we just made here is we're confident about our contract position, the pricing structures that we put in place. We're tracking well for positive price cross spread here in the first quarter, as we had previously indicated. So as -- on an as-is position right now, it's in a good place. There's about 400,000 tons of glass that comes from either Russia or Ukraine that get exported into Europe. And obviously, that at this point in time is likely cut off. So that will probably put additional demand tension into domestic producers within Europe, and we'll have to see how that is. As we mentioned before, the business is already running very strong. Inventories are low. Capacity is tight. So we're trying to work with our customers in the broader market to be able to service their needs, but it's early in the game.

So with that sort of discussion on the near-term outlook, I want to move a little bit to operations and then strategy and returns. And so on the operations side, can you give us a quick update on what's going on with Holzminden and the overall launch in MAGMA. Specifically, and I know you said it before, but if you can remind us how MAGMA ultimately can lower the carbon footprint for O-I both with sort of Gen 1, Gen 2 and ultimately with Gen 3? Just a minute or so on that, that would be great.

Yes. Yes. Sure, exactly. So keep in mind, we're developing MAGMA in 3 generations. The primary focus has been on Generation 1 last year, which was where we put our first commercial grade line in Holzminden in Germany, and that went in online mid-2021. And so we're -- we've validated what we wanted out of that. Now as we indicated, the real work this year in Holzminden is optimization. So you learn a lot, right, and then you tweak things whatever, so that what you can walk off with then is a MAGMA Gen 1 that you could confidently replicate consistently going forward with the learnings that we have there. So that's kind of what we're gaining to do this year. And the Generation 2 is focusing -- this is at our Streator pilot. It's more of the end-to-end process. So using the melter, looking at more modular batch systems, scale down batch systems all the way over into other forming machine technology and whatever. And so what we want to do is validate that end-to-end process that we're -- we have it all in place. It's all running and it's all being piloted right now, making sure it's operating the way we want it to. And then that will follow a period of value optimization too. Then that will converge. Those 2 solutions will converge into the solution we would look to replicate and use for those up to 11 lines that we indicated would be the expansion activities over the next 3 years above and beyond the work that we're doing in Colombia and Canada right now, which is leveraging our heritage technologies.

So with Gen 1, Gen 2, just remind us what does it do carbon footprint-wise? And then as you bring on Gen 3, hopefully, what does it do? Just a minute on that or so.

Yes. Yes, sure. So there's a handful of things that allow the MAGMA solutions to improve the carbon footprint, okay? The first is the ability to co- and near locate with our customers, okay? So when we would look for imagine -- so the secure co-location, that can tick -- reduce up to 80% of the transportation costs that go out between us and our customer. It can use a broader array of recycled content, which we know sometimes is hard, right, to get the whole recycled. So if you're going to get a broader range, you're going to have a higher recycle content and all the advantages of that. And then ultimately, you can -- this would be more of a Generation 3 solution, you can use biofuels, hydrogen. And then that sort of the Gen 3 solution will allow up to 30% lightweighting of the product. All of those together in the ultimate sense could reduce up to 95% of our greenhouse gases. Now I think most of that reduction is more back-end loaded to the Generation 3 solution because it requires those elements. But even the projects we would look to do over the next 3 years, we would look to be more near location with our customers because the greenfield, brownfield that allows you to get to a lot of the transportation-related sustainability improvements.

Yes. I mean the reason I bring it up is we held a panel as we always do at this conference on sustainability and around plastics and the plastic guys. And then we had a plastics technology session as well. Obviously, they may be a little bit more biased towards their technology, and they cited the greenhouse issues for glass and it's like, well, you haven't really looked into MAGMA just yet. And so that's why I was firmer. I think that could change the view and the...

Absolutely. I think we're very mindful of it. As I said in the prepared comments, I think we've got a lot of levers when you think about technology and type we have, it's very much focused, and it's great that we were able to design this new technology with all of this insight in the importance of ESG going forward.

So John, I want to switch as we were saying to the returns. And so while O-I from our analysis has 100, 200 basis points higher margin than a lot of the other beverage packaging companies in terms of EBITDA, since the mid-2010s that gap is compressed a bit, call it a couple of hundred basis points from our work, even as return on capital is now at parity with that group as well. And what do you think from what you've seen is causing that? Is that you've seen perhaps more near-term cost pressure? Do you think -- well, it doesn't sound like, given your growth categories that some of the premium categories that you used to sell into are less adopting of glass. What's driving that? And what resolves it going forward?

Yes, sure. So let me talk about segment profit margins because that's more closely on my mind. So back in the mid part of the last decade here. Our segment profit margins are between 13% and 14% or so. And you're right, they did dip down in 2019. 2019, we struggled with some change management activities with some changing end-use categories. And then, of course, 2020 was the COVID year. But if you take a look at the numbers back in 2021, they were 13.2%, I believe. So we basically are rebounding back to what that level was. And as we indicated at our Investor Day, we expect up to 150 basis point improvement over the next few years. So why was there the dip? And where do -- what's driving us going forward? So I think the dip in the prior years, as we know some of the challenge -- if we slice and dice our business by market and end-use category, everything is going in the right direction. The one that we all know that has been a challenge for the business has been the mega-beer category in the U.S. And that was a function of substrate shifts that were going on in value-based categories as well as the emergence of hard seltzers and that taking a bite out of beer overall, not just glass. Now a lot of that has kind of played its course and mega-beer for us is now just 4% of our global portfolio. U.S. mega-beer is now 4% of the global portfolio. So it's not the headwind and pressure point it has been in the past. So that hopefully is not the headwind. In fact, a lot of the other aspects that we're talking about growth in -- just what we've seen in the last several quarters, very good growth out of Europe, a lot of categories coming back on. We're seeing very good growth in the wine and the spirits and champagne categories that are better margin categories.

And that mega headwind used to be a little over 1 point to your top line now?

Yes.

It's a fraction...

It's a fraction of a point -- I mean 0.2, 0.3 kind of type of headwind. So the capacity just kind of kept all the other growth in the other categories from shining through. And now I think you're going to be able to see good growth trajectories.

So from your analysis -- so let's take a step back. You've done everything you can to position O-I for growth. You have this investment program coming. And so then the next opportunity and for investors is will growth be there? Are you getting dressed up for a party? And will the party be held? And so from your study and -- of consumers and also from your discussion with the brand owners, is the consumer ready to adopt more glass again, especially as I've thought about it, perhaps a lighter weight bottle? So it was -- it used to being a little bit heavier and more stout. And is the brand owner willing to make the investments in filling and distribution efficiency to use more glass, because then the party goes on?

Yes, exactly. So I mean I'll go back to -- we showed it in some of our materials last year. It was a McKinsey analysis on consumer perceptions of sustainability by end-use package. And by far, glass was perceived as the most sustainable, eco-friendly item out there against all the other package -- rigid packaging options. So we believe through our analysis and other things tangential to this, the consumers want glass. And I think it's playing out, our customers are hearing the same thing. And as we talk about expansion of our projects, we're doing this with secured long-term agreements from the customers, and they would only do that if they believe that there is the trajectory for demand going forward. So in that sense, it's going quite well. The sustainability area is probably playing out mostly in the food categories that tend to have a lot of plastics and pouches and things like that and not to say that they're all switching over to glass or anything like that. But as they look to differentiate and have a portfolio -- a differentiated portfolio of their packaging options, glass is a great fit for a lot of the premium categories that you would have within -- which are the niches of business. And even if this is just a piece of the pie, it's very important for our business.

You wouldn't be doing a long-term agreement with O-I if you weren't confident in the growth. But -- and so that's a point really well taken. From your sense, are they investing in the filling lines to...

Yes. As they expand their businesses, and most of the growth that we're signing up for with our customers is because they have similar expansion going on in their business and building out their breweries or packaging lines and things like that. And it correlates with their investment in the packaging -- filling lines and things like that.

Are there any questions from the audience? Any questions for John? John, maybe the last question I have for you to wrap up, and again, thank you for your time. Chris, thank you for your time. It's an honor to have you here and be in person. In a nutshell, what would you say O-I's strategy is? What choices are you making to support that strategy. And at the end of the day, and it's going to be on a number of fronts, where do you think you're best in class? Where do you have the most work to do versus the peer set?

Yes, certainly it always starts from the marketplace, right? And as we look at the attractiveness of the categories that we serve and our capabilities, one of our top ambitions is to continue to expand on our very strong franchise position. So you think of Latin America or you think -- and also the categories with very high glass affinities. And so we've talked about our growth in Latin America, I talked about our focus on the spirits categories, for example, in glass. So we -- that's our top priority. And then over time, it's addressing more of a fragmented, differentiated market that has historically been a bit challenging for legacy assets, which are generally geared for large runs. And we believe that 30% to 40% of the glass -- potential glass market out there is this more differentiated category. And with MAGMA being the right solution for it going forward, we can go more cost effectively and with the right service levels to be able to meet the needs in those particular segments. With that are also some of the fastest-growing segments that we serve. And you got a backdrop of that and continue to clean up the balance sheet and continue to clean up the operations, eliminating asbestos, which has been such a detrimental aspect to so many aspects of the business and a terrible disease, of course. So I think that's in a nutshell what we're trying to get done.

Okay. Great rundown. John, Chris, thank you very much. Everybody, please join me in thanking O-I Glass.

Thank you for your interest in O-I Glass. Appreciate it. Yes.