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

Great to see everybody. Most importantly, great to see O-I Glass here or as some would say, Owens-Illinois. If you guys can deal with that. Here from the company are Chris Manuel, who we know from Investor Relations in the front. If you have any questions as well as John Haudrich, Senior Vice President and Chief Financial Officer of the company. John, as we know, is focused on O-I strategy, execution, performance management, and financial decision-making. He has leadership responsibilities maintaining financial flexibility for the company and a number of other initiatives. John joined O-I in 2009. And without further ado, I give you John Haudrich and O-I Glass. John, take it away.

Thank you, George, and the Bank of America team for hosting us today. This morning, I plan to discuss how O-I represents an attractive investment opportunity. Afterward, be happy to take your questions. Before we proceed, please review the safe harbor comments on Slide 2 and various disclosures found in the presentation which are posted on our website. On Slide 3, you'll see a high-level profile of the company. O-I is the global leader in class packaging. We serve the highly stable and steadily growing food and beverage industry, supporting more than 6,000 customers. These customers value our dedication to service and our unparalleled production network to meet their needs across the globe, recognized by a continuously improving Net Promoter Score. As the industry leader in innovation, we are proud to make glass the most sustainable packaging solution. Likewise, it is the preferred substrate by most consumers given its premium characteristics and their increased focus on health and wellness. Last year, O-I passed an inflection point in its long corporate history. In July, Paddock emerged from bankruptcy after achieving a fair and final resolution of its legacy asbestos-related liabilities. As such, we expect to generate substantially more cash flow each year that can be deployed to expand our business, reduce debt and create value for our shareholders. At the same time, we are developing MAGMA, a revolutionary new glass production process that will augment profitable growth and boost our financial performance. Let me expand on this strategy starting on Page 4. I strongly believe O-I represents an attractive investment opportunity. Over the past few years, we have developed a very good track record on performance. In fact, we have either met or exceeded consensus for 12 consecutive quarters. At the same time, we have reduced risk by resolving legacy liabilities and improving our balance sheet. This improved performance is supported by agile execution enabled by strong capabilities we have built over the last few years and the bold actions we are taking to transform O-I. Likewise, we are capitalizing on the strongest glass fundamentals in decades to drive profitable growth. Importantly, MAGMA represents a breakthrough innovation that creates a new paradigm for glass to meet the needs of an evolving market and expand our business. Finally, as the most sustainable packaging option, glass is set to win in the new green economy. Let's expand on each aspect of the strategy a bit more. Moving to Page 5. We have delivered consistent earnings and balance sheet improvement over the past several years. As you can see on the left, adjusted earnings per share have increased nicely since 2020. We expect further improvement in 2023, supported by good net price and continued incremental impact of our margin expansion initiatives. Looking forward to 2024 and beyond, our ongoing capacity expansion and margin expansion initiatives should enable additional earnings momentum. As shown on the right, we have significantly reduced our financial leverage over the past few years in addition to resolving Paddock's legacy asbestos liability last year. We expect continued progress and anticipate leverage should drop below 3x by the end of 2023 with a longer-term target of 2.5x over the next few years. Overall, our balance sheet is in the best position in over a decade. I'm now on Slide 6. We have also been hard at work transforming the company. The team started by building a simple, agile, and effective organization. We are optimizing our structure, as discussed, Paddock resolved its liabilities, and we completed our $1.5 billion portfolio optimization program well ahead of schedule. We are more cost competitive as a result of our margin expansion initiatives, which have generated around $320 million of net benefits over the last few years. As a result of these efforts, O-I has been able to overcome elevated market volatility, reduce debt as we increased our adjusted free cash flow conversion to over 35% last year. Now we are squarely focused on advancing MAGMA, which will enable a more flexible, scalable, and sustainable production capacity as well as increased supply chain efficiency. All this will support profitable growth, which I'll discuss more on Page 7. We believe glass has a bright future. As illustrated on the left, our sales volume, including JVs, has increased about 1.5% a year on average over [Audio Gap] period, resulting in the strongest glass fundamentals in 20 years. This is being driven by a number of factors, including increased consumer preference for premium and healthier products and packaging, structural market shifts, and oversold conditions amid strong demand in several key markets. As a result, glass demand is now expected to grow 2% to 4% a year in the key markets that we serve over the next 3 years. We continue to advance our capital expansion program to capitalize on these trends. In total, we are adding new capacity to support 5% to 6% profitable growth through 2024 with an average return of around 20%. In addition to these programs, we have a solid commercial pipeline in excess of 1.6 million tons, representing future opportunity for additional growth. On Slide 8, you see the 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 that we have served for decades and will continue to serve in the future. Given the trends in health, wellness, and sustainability, there are significant future opportunities in a broad array of end-use categories, which tend to be more differentiated and fragmented. MAGMA is a perfect fit to expand in these categories. MAGMA is more flexible, scalable, and can be more rapidly deployed. It can be co-located to improve supply chain efficiency. It is more cost-effective with lower capital intensity. Likewise, MAGMA can be used with ULTRA to allow significant container light weighting and MAGMA will enable future use of carbon-free energy sources like hydrogen and biofuels, so it increases convenience and sustainability. MAGMA represents a major leap forward in how glass is produced and will expand O-I's right to win in its addressable markets. Overall, we are targeting returns in excess of 20% for future MAGMA expansion projects. Moving to Page 9. We are very excited about our first MAGMA greenfield plant in Bowling Green, Kentucky, which is on track for initial commercialization in mid-2024. We are designing the plant to be a showcase facility that will demonstrate all of our next-generation capabilities. The new state-of-the-art facility will include the MAGMA melter, new modular batch system, and pilot forming machine. It will be fully digitized with a high-performance operating model. This highly scalable plant will eventually include all MAGMA Gen 1, Gen 2 and Gen 3 solutions with a next-generation sustainability features as well as our ultra-light weighting system. Located on the bourbon trail, the Bowling Green plant will demonstrate the value of near location and will be a key hub for future customer collaboration, investor visits and demonstration of O-I's next-generation capabilities. I invite you to view a recent video that we created that shows MAGMA in action and further discusses its many important attributes. The slide includes a link to the video. Sustainability is another critical element of our strategy as glass is set to win in a new green economy. I encourage all of you to take a look at our updated sustainability report, which can be found in the company's website. We added a few highlights on Page 10 with more details in the appendix. We are already more than halfway to our 2030 emissions reduction target, and we are implementing new technologies to further reduce CO2. Renewable energy now represents more than 27% of our energy source, and we are well on our way to our 2030 target. Likewise, we are expanding recycling collection sites and funding numerous projects to expand collet usage. As noted, MAGMA and ULTRA will also provide significant sustainability benefits in the future. Overall, we're making solid progress, which has been recognized by a number of organizations as noted at the bottom of the slide. Glass is already the most sustainable packaging solution. I believe it will be hard-pressed to find many industrial companies with so many levers to further improve their sustainability position. O-I has established another set of ambitious and achievable objectives in 2023 to advance our strategy. This is summarized on Page 11. Higher earnings and margins should benefit from strong net price realization and our ongoing margin expansion initiatives. As you can see, we have increased our annual initiative target to more than $100 million, which now includes a set of focused initiatives to advance performance across targeted operations, primarily in North America. We have already discussed a number of other focused areas this year, including expansion initiatives, technology development, ESG, and capital structure improvement. I am highly confident these efforts taken in concert will advance our strategy as we continue to transform O-I. Let me touch base on our business outlook. I'm now on Page 12, which recaps our most recent guidance provided during our year-end earnings call. As noted earlier, earnings have consistently improved over the last few years, and we have either met or exceeded expectations for 12 consecutive quarters. We expect this momentum will continue and anticipate continued progress in 2023. Importantly, we now expect first-quarter adjusted EPS will exceed guidance as performance has been stronger than originally anticipated. While sales volume will likely be down mid-single digits amid a very challenging prior year comparison, our improved outlook reflects strong net price realization as well as solid operating and cost performance. Of course, we all face elevated market uncertainty and volatility as well as a potential recession. Keep in mind, we have factored some level of macro risk in our full year outlook, especially in the back half of the year. Despite this, we have a constructive outlook on 2023 and expect to reinstate a full-year adjusted EPS guidance range during our next earnings call. Let me cover our capital allocation priorities. I'm now on Page 13. Improving our capital structure remains our top capital allocation priority. As noted, we expect leverage will end the year below 3x. We will continue to reduce debt consistent with our glide path to 2.5x leverage and expect to eliminate our net unfunded pension liability over the next few years. Our second priority is to fund profitable growth. This includes our current $630 million expansion program. We do anticipate continued modest portfolio optimization as we seek to increase ROIC, which could also help debt reduction or expansion. Returning value to shareholders is our final priority. We will continue our anti-dilutive share repurchase program. Likewise, we may evaluate additional share repurchases or reinstated dividend as we get closer to our capital structure objectives. Let's turn to Page 14 for some concluding remarks. First, the company is performing well, and we have a constructive view on 2023. O-I has a clear strategy to create value and redeploy capital effectively. As shared, we have consistently taken the bold actions to advance our transformation. Well, likewise, O-I is a much more agile and resilient company as we continue to successfully navigate elevated market uncertainty. Finally, I believe O-I represents an attractive investment opportunity as we reduce our risk profile, execute our transformation program, enable profitable growth, advanced breakthrough innovation like MAGMA, and further leverage our sustainability position to win in the new green economy. We are confident this strategy will create value for all stakeholders. Thank you for your interest in O-I Glass and George, back to you for questions.

Thank you, John. Thanks for the rundown. So I guess the first question I had you are now guiding to above your prior guidance range. You said net price is going well. You said operations have also done well despite the mid-single-digit volume decline, which is not a surprise. You've already got that. So to the extent that you can comment, what have been the 1 or 2 things that would be a common denominator on the price realization that's gone better? And certainly on operations, what's gone well beyond what you're expecting other than maybe you were just trying to factor in some conservatism given how uncertain the environment has been.

Well, so as we entered the first quarter and in our earnings call when we provided guidance, in particular on the first quarter, we were about 2/3 of the way through our annual price negotiation process. And so now we're substantially complete, and then we have a fuller realization of where we are. So that has ended up incrementally better than we originally anticipated.

Got it.

I would also say our margin expansion initiatives have gone better than expected in the first quarter. That might be ultimately be a timing element to be able to get in front of these upsides. And then as I have mentioned in my prepared remarks, we're really focusing on our North American operations. We see good upside. We see an inflection point there, and we made good progress on some of the fundamental contract restructurings and things like that going on in those marketplaces. Those all set up some to positives for the quarter.

Okay. So the contracts, I would assume would be more in the realizations in North America, would that be fair?

I'm sorry.

The contract discussions, that's part of the realization benefit, the net pricing benefit you're seeing in North America. On operations, maybe there is no one common denominator, but what's gone a little bit better than expected given the launch pad.

Yes. It really comes down to production efficiencies. We measure our business in pack-to-pull in these types of measures and that has just exceeded our original expectations. It's one of the best performance periods that we can see. At the same token, we've had some external disruptions, strikes in France, the civil unrest in Peru, and we had some impact of flooding in Northern California when the Bay Area had a lot of flooding. But despite that, the operating performance is very well. And then back to the net price component. Keep in mind, there's a number of elements that are driving the increase in net price. First, it is the annualization of the prices that we did last year. We had the price adjustment formulas that kick in contractually on 55% of our global business that is contracted. So that comes through, and that's picking up the inflation from last year. The third piece is, in fact, what we were just talking about North America and good progress on restructuring those contracts. And the final is this incremental price increase that we put at the beginning of the year. So if you take a look at all of those, there's a lot of sustainable aspects of those as we pick up historic recovery of inflation in the past. And keep in mind, the inflation this year is still 8% to 9% out there. I mean it's probably hit its peak back in the third -- in the fourth quarter. So -- but we're still looking at elevated cost inflation. So it's a good backstop for the net price realization.

And John, the 55% again, that is the number of customers or amount of revenue is tied up in the...

Long-term agreements. And those long-term agreements all have these price adjustment formulas that on an arrears basis. Sometimes it's annual, sometimes it's quarter, semiannually that recover the cost inflation from the prior year. We have actually made some progress on switching annual price adjustment for [ those ] to maybe semiannual or quarterly, which will help the business in the long run.

So recognizing there's a lot of inflation in the market, and that is one of the reasons that you should be recovering, are you getting any more pushback than maybe last year from your customers? We're starting to see some headlines, retailers saying, "Hey, supply chain enough on pricing, glass as a percentage of the overall cost to a big retailer is not a lot." But nonetheless, is any of that water starting to roll down hail from what you're seeing, even though you're getting the pricing now?

I don't think there's any practical impact of that right now. Of course, nobody likes pricing increase. We don't like it from our suppliers either. But it's part of the reality. If you look at energy in Europe, for example, last year, it peaked at about EUR 120 per megawatt hour. Obviously, it's down from that, but it's still 3x higher than it was on pre-pandemic basis. You have cost inflation now flushing through the raw materials. You have cost inflation flushing through on the labor side, you got higher interest expense, you got inflation on capital goods. So there's a lot of things. The company in this world right now has to manage its cash flows more than particularly these levers. So when you take a look at that in total, I think it's an environment where the price increases are very justified based upon the environment that we're looking at.

Sure. One question we've been asking all the companies that are here and to some degree, you gave the answer in your presentation, but O-I has been performing well. It's one of a number of companies that investors that are here who are listening on the web could invest in packaging and paper and forest. And then on top of that, our sector is less than 0.3% of the S&P 500. So to break through this group of stocks, the sector, let alone the broader market, what's the 1 or 2 things you want a PM or an analyst who is listening in to take away about why they should buy O-I right now?

I think it's a good question. I think I'll go back to even one of the headlines at one of your notes. This is not your grandfather's O-I. We have been transforming this company, and we made meaningful changes. We have -- the operating performance and execution is much better, much more still, the confidence is there. We've unconstrained the company. In many ways, we've taken care of asbestos, improved the balance sheet. Now we're really focusing on profitable growth with new breakthrough technology over the longer term. But at the same token, George, our valuation relative to others in the space is pretty low. And so it hasn't been fully recognized. So I think with the bias on the upside, the tension on the upside of what we have to perform a company in transformation and proving its successful in its transformation with upside there, I think there's a good reason people should take a look at O-I.

Thanks for that, John. And so on the operational front and the continued margin improvement initiatives that you've got, was that $50 million annually, and this year is going to be at $100. When do you -- when should we start expecting some deceleration in that? I mean you can't -- or can you keep doing $50 million a year from operational improvements.

Yes, I think we can. Companies that execute well, should target at least 2% cost takeout per year, at least on a gross basis, of course, the real world gets in the way sometimes and things get diluted, of course. But that's the type of productivity improvement a company should try to target. And...

Net of your inflation...

Yes, this is exactly. This is just productivity improvement in the business and inflation needs to be taken care of through price and things like that. So bucking that off in there. And -- but keep in mind also, our margin expansion initiatives is not just plant productivity. It's also revenue optimization. There's a lot of things -- if you go back to that North America story, contract improvement, a lot of terms and conditions, there's a lot of money that gets wrapped up in there, even how you manage pallets and tier sheets and all those types of things and get recovery, really add up on the position that we're at. Not to mention the OpEx side. We've done a lot. I think we've reduced our SG&A had kind of about more than 25% over the last 5 years, and we continue to optimize, and there's digitization and automation, and we're outsourcing things with a partner on managed services. So there's a lot going on that can continue this good trend. And I would also say, each year that we've comfortably exceeded our target, and so we're confident going forward.

Let's talk about MAGMA for a little bit. Tell me a little bit about in Bowling Green to the extent that you can talk because it's new technology. What's different about the melter here? And what's unique, what makes the batch process or the furnace process batch...

Yes. So keep in mind, a typical furnace, historic legacy furnace, about the size of the kids' gymnasium, maybe fitting in the room that we're in right now. MAGMA is 1/10 of the size as we get an idea. It has an on-off switch. It has increased flexibility. It's portable. It could be prefabricated, it can be done at a lot lower capital intensity. It's not a big capital structure. Ultimately, what we want to do is move from a big smokestack factory structure ultimately to an industrial warehouse structure that you can actually put on-site or co-locate with your customer. So it's a meaningfully different overall structure, and that's what we want to be able to show over in Bowling Green. In order to do that, what we have to do is reduce the size of all of the equipment and activity within the system. So if you go to a typical glass factory, you see the batch systems, there are some of the highest structures within the facility. So we needed to bring that, miniaturize that batch system down into something that also can fit with an industrial warehouse. And it's all part of the miniaturization process. That we put in.

Historically, what are the batches going to have to be so large? Is it the way you had you...

Yes. Well, the batch is the front end. That's where you're mixing the raw materials and including on that. And so it's a gravity-based system kind of going down and so it's structured that way. And it's still a large structure. If you take a look at the picture, you see where it's a little bit nudged up there on the left, that's the batch system inside of it, but it's still significantly lower than what we've historically have. It's an engineering feat.

So when we go back to the Analyst Day from September of '21, I think at one point in time, you talked about 4 or 5 perhaps factories being MAGMA factories, maybe a bit more than that. Let me recount. You had about 11 lines that you were talking about. And now we're down to a couple, 3 MAGMA factories. Is there any difference in terms of the breadth with which you're deploying MAGMA? Because based on what you just said, I would think you'd want to deploy it everywhere as opposed to at a lesser degree. So is it a lesser degree or no, it's just counting lines versus plants.

It's a fewer number but more advanced technology because originally, what we were going to do is run out those 11 lines, but they were going to be early Generation 1 technology in 11 different lines in different markets. Now supply chain issues happened and our development cycle kind of got impacted, call it, 6 to 12 months. We did have firm customer contracts that we had to honor. Otherwise, there's penalties associated with that. So we found some actually great projects internally that we could still leverage within existing technology. But more importantly, what we were able to do then is really accelerate the MAGMA Generation II and Generation 3 development and deployment of those because the original plan was we were going to run out 11 Gen 1 and then develop Gen 2 and 3 for deployment after 25. Within this one, you're going to have Gen 2 and Gen 3 between now and 2025, actually operating. And so that is a system that we really want to prove out in an operational setting so that we can then replicate. You really don't need 11 of them to fully understand the technology and its practical implication to be able to start the replication process. This actually advances our ability to commercialize MAGMA Gen 3, which is the one that has the most economic and customer value.

Again, maybe a simplistic question does the fact that you've got 2 recognizing it's more advanced versus the 11 because again, the proposition on MAGMA has been you want to be -- it makes you less capital intensive. Will this mean that O-I is maybe a bit more capital intensive in the intermediate period before you finally prove out MAGMA or?

No, not really. Because really, when we were going to do Generation 1, Generation 1 does not -- maybe it's 5% less capital intensity than a Heritage, whereas maybe a Gen 3 is more like up to 40% lower, right? So on the margin, it's a little bit, but actually, we found some really good internal projects on the margin that we can do that have really low capital intensity. So I think we're parity. In fact, George, our original program was $680 million of capital for that original program. It's now $630 million. So it's actually a little bit better.

Thanks, John. Any questions from the audience for John Haudrich? [ Rob ], if you can just wait for [ Linda ].

I was just wondering if you could comment a little bit around market structure for glass with, I guess, it's within North America. I've always viewed it as a local business or a regional business. Does that change at all with this technology? And then I suppose also what does this mean for the existing base -- a production base that you have and, I guess, that the industry has looking forward, please?

Yes, sure. Heritage technology that we have right now, you're right. You really want to keep it within a 250 to 300-mile radius of the facility, right, because shipping costs do add up with models. But the beauty of MAGMA is that you'd probably have a larger number of smaller facilities actually closer to the action, whether that is actually on your customer site or, for example, what we're doing here in Bowling Green, kind of near located on the bourbon trail, right, where there's a lot of customers. Ultimately with MAGMA -- so Heritage is still going to be a very important part of our base. We think ultimately down the road and MAGMA represents 50% to 75% of our system, but Heritage will still be out there. If you're running large beer runs and things like that Heritage technology, it's still your best fit. But as we try to get into the that-- we believe there's about 35% of the glass market that we have a hard time really addressing because we don't have the flexibility and the system to be able to get there. And that tends to be smaller customers, more fragmented business, which actually tends to be more higher margin business. That is a great fit for MAGMA going forward. So I think we're going to have a combination of both of those. But I believe over time, incremental expansion will be substantially on the MAGMA side. As far as the Heritage base, what we're -- we're having Generation 1, 2, and 3. As furnaces hit their end of life, which is, let's say, every 10 to 15 years, we would look to substantially replace those with a MAGMA Gen 1 solution that provides a lot of the value, maybe not the full value that you get on an integrated -- I mean on a full greenfield basis. And we may look at some of our facilities, we just say it's best just to close that facility and actually go all in on MAGMA for that book of business based upon where we're at. So that's all in front of us. And the important thing is if you look at the capital intensity over the long run, a MAGMA unit doesn't have a real end-of-life. It's not like a furnace that has to be replaced every 10 or 15 years. You put it in once and it's a machine and it has to be repaired and things like that. But you get out of this very significant capital intensity over the full life cycle of the asset. So it's really a win-win situation for the business.

So John, and again, I'm probably missing something obvious, but when a furnace does come up for rebuild, you're going to replace it with a Gen 1. Why not, if possible, with a Gen 2 or Gen 3 or it's just trying to match your furnace with the customer mix that you've got and whether it's...

Because if you take a look at a typical glass facility, the existing ones that we have right now, it's just the furnace that has an end of life that has to be replaced every 10 to 15 years. Everything else has a long life to it and everything like that. So we have to evaluate. Is it better to go in and as that furnace replaces, pull it out and add maybe 2 MAGMA lines and you get all the flexibility or in some cases, as I mentioned, we may say, "You know with the mix of business and everything, let's just scrap the whole plant, and let's go ahead and do MAGMA for the round-up." And that will be a situation-by-situation analysis.

Makes sense. I appreciate that. Maybe one last question before we wrap up here. And I know you probably get it frequently. There is not a lot of industry data on glass. The best we have is the North American data. We get some scanner analysis. You're projecting a -- and that data, especially the North American data remains relatively depressed. Now perhaps we're missing the imports from Mexico and other places. But why else should we be comfortable about the supply-demand outlook given that you're adding capacity? I think there's probably another 1 million tons being added from our work over the next few years and why this really good position that glass has been in, it doesn't erode somehow with obviously the optically declining volumes we're seeing in North America.

So first of all, on the later part first. If you take a look at it on a global basis, all the capacity that we're aware of, including our capacity expansions that we're doing over the next few years, we still see a structurally short glass market. There's not as much going in as we think is that 2% to 4% fundamental growth. And if you take a look specifically back to the North American marketplace, it's really a tale of 2 markets. I mean we know that there's been beer, and that has been the one that's rebased over the years. But keep in mind, that's only 4% of our global basis that capacity is the mega beer. That's like 14% of our North American business anymore. So it's a relatively smaller piece. But you're right, over the last 6 months or so, I think you saw a decline in beer and you look at the beer packaging index. It was in the 40s and 50 is the breakeven point. But really, this last month, it became -- popped back to 54. So we'll have to see whether that was situational or whether it sustains itself. But underneath it is very good activity in the spirits and the wine and the food categories and things like that. Beer has been the one that's rebased, but again it's not as big of an element. And one thing I'd say is that we have been renegotiating, as I mentioned, a lot of our long-term agreements, right? And that includes beer and all the different substrates. And we're having very good success in how we're structuring them, which also to us is a signal that our customers really value glass as a substrate in their product lines.

Okay. Got it. Great story. All right. Great performance. Thanks, John. Everybody, please join me in thanking O-I Glass for a great presentation. All right.