Packaging Corporation of America ($PKG)

All right, everyone. Thanks for being here. Gabe Hajde, for those of you who may not know Wells Fargo Senior Paper and Packaging Analyst. I'm joined by my colleagues today in the room, Richard Carlson and Bailey Gordon. We'd like to welcome you to the Packaging Corporation of America presentation this morning. Representing the company are Chairman and CEO, Mark Kowlzan. To my right; and CFO, Kent Pflederer. Mark has been with the company since 1998. I believe I got that right, CEO for the past 16 years and Chairman for about a decade. Kent took over as CFO just about a year ago, been with the company for 19 years and has also served as PCA's General Counsel. Many of you in the room are familiar with PCA. They are solely a domestic producer of corrugated products and office printing paper, been in the corrugated business. They're the third largest supplier in North America, but often considerate best-in-class for sure from a margin standpoint, balance sheet management perspective, capital allocation. On that note, I think you guys bumped our dividend last month by about 20%. So again, thank you all. This is intended to be interactive. So take sent there are questions. I think there can be a microphone for that. And with that introduction, I think, Mark and Ken, you guys put out a slide deck pretty recently and have a couple of prepared remarks.

Yes, our deck is on our website, too. And then we want to start the fireside chat with a business update probably take me 5 minutes to go through this, but it will set the stage for a good Q&A after that. So before I begin, I just want to refer everybody to the forward-looking statements, cautionary note that we always make in terms of actual results could differ materially from those expressed in the forward-looking states. So with that, we'll get into a good news. Corrugated volume remains robust, and we finished April and went through May at levels consistent with what we told you on the April earnings call. For April and May, corrugated shipments per day were up over 24% compared to last year. On a legacy basis, the shipments were up 4.5% in April, 3.5% in May, so a very healthy period. Bookings were also very strong in both months and continue to be strong in June so far. While macro risks certainly persists, the economy remains resilient and customers are not signaling a slowdown with their ordering patterns. Now some bad news. Freight and recycled fiber are headwinds. Thus far, we've done an excellent job managing the fiber piece of this. And even as recycled prices have escalated more than we planned, we are slightly favorable to guidance for fiber through May, helped primarily by shifting our usage towards virgin and maximizing yields. However, freight is expected to be in the neighborhood of $10 million to $12 million unfavorable to guidance for the quarter. Freight rates continue to increase into May and are still near peak May levels. We do not expect any freight relief in June. Additionally, we've had to ship greater distances and utilize more spot freight to keep our box plants supplied in the very tight conditions we're running under. As for pricing, -- we are right on our forecast through May, like we told you on the earnings call in April, the first net $50 increase is beginning to be meaningfully recognized and corrugated in June with substantially all of the rest coming in during the upcoming third quarter. Given our inventory and demand situation as well as higher freight and other operating costs, -- we increased containerboard prices another $50 effective June 1. This increase is now being implemented, and we would also begin to meaningfully show the results in the third quarter. To comment further, containerboard conditions are very tight, and open market supply is hard to find. We drew down over 90,000 tons of inventory in March and April as we had very strong corrugated demand in a heavy annual planned outage schedule. We needed to begin rebuilding box plan inventories in May and June to support a seasonally stronger back half of the year with expected continued corrugated demand growth and more planned linerboard mill outages in Q4. We hope to exit the second quarter with inventories at or a little above where we began the second quarter. To help us accomplish this, we've had to reduce or defer some of the export sales in May and June and we'll see lower outside sales in the second quarter than we had forecasted in April because of that. The acquired Greif operations are having a very good quarter so far, with very strong volumes at the corrugated operations level supported by excellent performance at the mill level. The mills had a record production month in May, and frankly, there's room to do even better with some more operational consistency. But we're getting there as we had planned, and we're very pleased with what we're seeing. And it's also, as we said in April, we expected and we're seeing this. It's continuing to contribute to the bottom line now. Even with higher freight and recycled costs, the acquired operations are on forecast, consistent with what we told you on the April earnings call. So where does this leave us now? While we called out freight unfavorability against our guidance for the quarter, it should largely be offset by stronger-than-expected volumes. The resulting efficiencies in the cost structure from running full as well as favorability in other operating costs, reducing export sales and building some inventory will hit us for $0.03 or $0.04 in the second quarter, but will ultimately benefit us with higher integrated sales in the box plant side of the business. Price is right on plan so far. The first increase is proceeding normally and Greif is contributing to the bottom line. So where does this put us in Q2? To be clear, we are not managing to make the guidance that we gave you on the April earnings call, but rather to set this up to serve our customers to the back half of the year in a very tight market condition. That said, a good June could help us achieve the guidance number. What that will require is continued strong corrugated volumes and price realization. That freight and recycled prices don't continue to increase but stay around the May levels, and we operate at our potential across the mill and box plant system to maximize efficiency and continue to control costs that we can control. And I think that you can take what I said that the third quarter is, in fact, setting up very nicely. Obviously, demand will be the key to how nicely, but we should have some price tailwinds higher production with a limited annual planned outage schedule and appropriate levels of containerboard supply to satisfy our box plants and customers with continued demand growth and higher seasonal volumes. So with that, Gabe, we'll go ahead and just open it up for Q&A and discussion between you and any of the investors.

Thank you for that opening update there on the quarter. A little bit of a sneak attack on us, but I think, overall good news. So a couple of things. I want to make sure I got some numbers, right, up 4.5% in April, up 3.5% year-on-year in May. And so we always get this question, end markets. I even cringe when I asked this question. But one of the themes that we're hearing from a lot of our peers is we're starting to see this data center build out. And to the extent there are components whether it's electrical or otherwise that are going into those. Just anything that you would call out, it feels like the industrial aspect of the economy, so less so on the FMCG side is doing better and showing signs of life, we're seeing on the PMIs any color you can give us by end market?

I think what you just said is true. For us, across the board, our customer base is very strong. Ag is a good example. Different parts of the country had a very strong ag season. Some parts of the country had winter weather in January that impacted the Florida was a good example of the January freeze. But all in all, ag has been strong, but manufactured goods are very strong. What you're saying about data center buildout, electronic components, even on the automobile side of things. When the world it pushed to go to EV, there were less engine and transmission components. We historically had shipped a lot of product between the auto producers in their production lines, the transmission components, engine components. So that's starting to come back now as more combustion engine production is taking place. So we're seeing pretty healthy activity across the board, even some of the homebuilding, manufactured goods that go into the home building products. We've seen our manufacturing activity there pick up. So it's a pretty healthy broad pickup with all our customer base.

So you guys made the Greif acquisition. I want to kind of continue to build on this. It's -- from our vantage point, positions you well to continue to kind of outgrow the market. I had the question situated a little bit differently. But as we see this inflection should it persist how do you feel like from a capitalization standpoint, from a resource standpoint that you guys are positioned to should this like should it continue, especially with some of your peers and sort of retrench mode be able to monetize this on a go-forward basis.

Yes. Greif is going to be the -- you've heard us use the expression with Boise over the years at Greif will be the gift that keeps on giving for the next few years. We'll continue to get more production out of the Matalan Riverville mill. We're continuing to improve how we go to market on the core choice corrugated side of their business. and what we can do with the equipment we have there. So that will be another opportunity that continues to play out well for us. As far as containerboard production, we've always said this. We've got enough containerboard in our system with what we're doing for the next couple of years, but that's a high-class problem for us. We're always looking out in the future, but how we grow our mill system out where we get our tonnes from and -- but it always provides a challenge/opportunity for us. But Greif, I'm very pleased with what we're doing. May was a record month in the 2 mill operations. As a matter of fact, the Massillon mill had the best month in its history of operation. And that's saying a lot. So again, I'm very pleased with what we're seeing out of the Greif business. Ken, do you want to say anything?

Well, also the corrugated operations are having a very, very strong second quarter now, and we're excited about that, both what they're doing and also what they can do. some -- a very good profitable bulk bid is on top of the sheet feeder business and some potential good opportunities down the road what we can do there.

April and May were some really good numbers coming out of the Core Choice side of the business.

Okay. One of the things -- 2 things. One, we get pushback sometimes are 1 of the bear thesis on the industry, which I think you don't spend much time thinking about is, hey, they're flashing production here with America capacity. That's not a real way to run the industry. It's more on the price side is where I'm going with this is that by our math, there's been maybe $25 a ton of inflation on freight logistics costs. And now I think I don't want to pick troughs but recycled fiber is probably up to $25 a ton, maybe wipes out the first price increase. And so now we're sort of on to the second. However you would contextualize it? Do you feel like with the second price increase that you will have recovered this year's inflation? Or are there aspects that we're still chasing.

I'll let you know . Yes. I mean as you can tell what the comments I just made about what the energy costs have done transportation -- and it's interesting when you talk about OCC cost. It's not just the -- what it cost to buy a ton of OCC. It's delivering that ton of OCC 2-year plant to your mill, the transportation element of that. So OCC is up because it's commanding a higher price and it costs more to get it to your mill significantly more because of the diesel costs as an example.

But we're doing a very good job managing the cost structure outside of the transportation piece. We talked a little bit in the prepared remarks about how we -- we're doing a good job on the fiber side.

We've always talked about fiber flexibility in PCA. -- even though we have gone up in the recycled content with the Greif acquisition, we still have the best positioned mill system in terms of integrated capability with wood converted to pulp in our mill. So -- so we take advantage of that. And now is a good example of how we're taking advantage of the integrated Virgin craft. And so it's paying dividends for us.

One last one on costs. So you called out $10 million to $12 million on the freight side. I don't remember off the top of my head, the cadence of maintenance expense, but I think it was supposed to go down in the third quarter.

A little bit, yes.

Yes. Okay. And then you're talking about ending the quarter, I think, with flat inventories, which suggest. I think you said down 90,000 tons, so you'll build in the month of June. So we drew down in the straddle months on the quarter, March and April. We went down about 9,000 tons in those 2 months. So we had to enter build mode again back in May to get us back to where we really need to be at the end of the second quarter to support the back half of the year. And does that serve as a tailwind is kind of question number one.

And that's -- if you think about some of the comments I just made, we actually deferred some of our export sales that we shipped to probably 30-some-odd countries around the world. We don't ship a lot to any 1 country. It's a few thousand tonnes here or there. But because of the domestic demand in our box plants being so high, that's our priority. That's our highest margin business. We actually have deferred some of that export sales to the domestic containerboard outside sale in order to accommodate what our box plants need 2Q and into 3Q and 4Q in terms of -- because 3Q is always going to be a big big volume and now with the e-commerce in 4Q. So we're really setting up a comment I made we've taken a little bit of a potential impact in 2Q, but it's for the benefit of the back half of the year. So it's a high-class problem to have. But think about the number. I mean, to draw down 90,000 tons of inventory for PCA. I can't remember the last time that number has ever been that big in a 2-month period of time. And so -- and even though we had some mills going down for their annual shutdowns, we didn't have any extraordinary -- it wasn't like we were rebuilding mills and doing conversions this year. They were just the annual shutdowns for a week, but it speaks to how strong the volume really is that we pulled 90,000 tons out of our inventory system. And I mean to the point the box plants are every day, it's -- it makes me smile and they're raising their hand, needing more and more to take care of what their customers are telling them. So we're in a good place. .

Okay. So I'm going to flip gears a little bit. I mean, I don't think the message is to be clear, I think, on the 237 guide for the second quarter is that kind of depends on the rest of June. But I also think folks that invest in PCA don't worry necessarily about the current quarter, it's about the medium, long term. I'm going to go back to something you said about the industry being tight open market tons. And again, some of the supply rationalization that's occurred. Some of the work that we're doing and the feedback and I think some of the bullishness on the industry is that when you think about asset replacement costs or how to recapitalize your system. You guys have done a really good job over the past decade doing that. Mills are getting more expensive to either build fresh, a different market. But $3,000 a ton to build Waco is a pretty high benchmark. So do you think that's driving different behavior in the marketplace in the kind of current near term? And then from your vantage point, what could that do for the industry or margins or however you want to express that sort of over the next 5 to 7 years or...

Well, I think again, it sets up the industry for a very good period of supply/demand and pricing in terms of how everybody has to go to market. But the barriers to entry, if you think about over the decades, people would say, well, we'll build a mini mill. Well, 10, 15 years ago, you could build mini mill for $300 million, $400 million. Now to build a mini mill, you're talking well over $1 billion to $1.5 billion to build a mini mill. And so the barriers to entry to become incredibly financially, great. So it's going to create a pause in how people think about the potential returns on a very high-risk investment because if you build a mini mill, now you're going to go sell the tonnes. So it's not always an easy build a mill, and we're going to go move tons out into the marketplace. So I think -- the industry is in an interesting place right now. We're in a really solid position with our assets. We've been doing this for 30 years. We've been reinvesting, focusing on our what we do well. We've been growing our organization capability. And so whether you call it just good fortune good planning, but our assets, our organization are an incredibly capable place right now to take advantage of the market for the foreseeable future.

What's the same good luck is good preparedness eating opportunity? So okay. So I guess sticking with the -- or going to mix of business, I think that's evolved a little bit for PCA over the past, call it, 3 years. Can you talk about that? The origination of that, the initiatives to change or if it was a function of where the growth was a so kind of the state where the puck was going and what that looks like maybe.

Well, we been on the converted side of the business, we've maintained that flexibility that we grow with our customers for decades and decades, you've heard the number -- 2/3 of our business or local account business. maybe 20 years ago, that was a small local account, and now it's a big -- not just a local account, but it may become a national account. They have one time was a local account. But we continue to have a very close relationship with the customer base. where we remain very nimble in terms of how we can accommodate our growth needs. We work with them and understanding what they're going to do with their investments so that they don't have to worry about where their boxes are going to come from. And the way we run the capital program, we can shift capital needs and capital opportunities in a very short period of time to accommodate what we see happening. As an example, we maintained a standing order with one of the converting producers out there in terms of a converting piece of equipment that we favor. . But we have a standing order in with that producer for at least a half a dozen of their converting lines every year. And in some cases, we don't have a designated home for them yet. We just know we're going to be using them when they get delivered in the following year. And so we have that capability ongoing that we're able to bolt these down and get going and take care of the customers. So that's just kind of one simple example of how we're able to take advantage of the of the engineering organization we have and the marketing and sales prowess that we have, that we execute very quickly and take care of the customer and do it in a very profitable manner.

So on that downstream, the converted box aspect of the business, do you see any opportunity? I mean, I think 4 or 5 years or so, we had down shipments. Now we were coming off of an unrealistic peak during the pandemic. But I'm going to say grocery delivery or again, places where you can deploy capital to capture some of the potential growth areas over the next couple of years. Are you seeing any green shoots there or anything as it relates to new end markets that were not necessarily as big today but could be.

I'm not going to get into specifics. Our sales and marketing people are always working with the customer base in that regard. And -- and that's one of our people talk about secret sauce. That's one of our capabilities that we're able to move very quickly with that type of a customer need and that they can depend that we will take care of them in that regard. So as they're moving very quickly into that new opportunity, we're in lockstep with them, taking care of their packaging needs. So it's been a good relationship with a lot of our customer base. .

I want to bring up an unfortunate circumstance up in the Pacific Northwest. There was a mill incident. And you recently kind of reoriented some of your production up there. I'm curious with, I think, NORPAC from our understanding, limited running at this point. Are you seeing any change in your order book up in the Pacific Northwest as a result of that?

No.

Okay. Let's see here. So you raised the dividend, capital allocation. Are there other opportunities? I mean, you obviously just rife the balance sheet will be back to where you want to be -- are there other opportunities that are out there on the M&A side?

There always are. We're always looking at different things that come available. We pass on a lot of things. A couple of the announcements that have been made recently. We were aware of. We had looked at, we passed on. They just didn't hit our metrics and our financial requirements on returns. So -- we're always looking. There's always something for sale. But I've been running the company for over 16 years. And during this period of time, we've made probably 27 acquisitions. And Boise and great for the 2 biggest, but we've made a lot of acquisitions, growing the company, done very, very prudently. And I think the investors appreciate that.

Yes, we maintained the balance sheet flexibility to do that, but we've also proven that we've gotten very good returns and value generation out of our internal capital spend and we return value to our shareholders, and that's an important priority for us as evidenced by the recent dividend in Greece as well as some share repurchases.

I think it's interesting when you started out on this last question, if you went back to the 2021 period of time and then '22, '23, '24, '25, there was a decline in industry volume. PCA during this period of time, [Audio Gap] is actually up in volume during this period of time. And so -- but if you went back over the last 30 years. It's the same thing. We're probably up 300 on an organic basis and then the past acquisitions, were up over 300% volume in our box side of the business. But the industry stay down and -- but yet, we just continue to outpace the industry. Now there's been some quarters where we haven't. Part of that is if you're dealing with a big competitor that makes an acquisition and then they layer on that volume. But over the period of time, we significantly outperformed all of our competitors and our box volume growth -- and we've done that decade after decade in the plan as we will continue to do that. That's how we're built, that's how we're organized, and that's how we think.

Anything in the audience? Just suspect the answer is no. Typically, people aren't reason to ask a question. Okay. I suspect I know the answer to this question, but I feel it's a little obligatory. You have a lot of gas in the tank. I know you're passionate about this business. People look up to you and the organization. You spent a lot of time recruiting engineers. That's something I think that's a differentiator for PCA over time. . So 2-part question. One is, can you talk about that a little bit and why that's important in the organization? And then kind of the succession planning, I still think you've said you guys start a couple of years left, but just folks in the organization that are chomping at the time.

Thomas Hassfurther and I are the same age. And Tom just celebrated his 49th year at PCA. And I've been in the industry as long as that. And I don't have enough hobbies to occupy my time. So I like doing what I do. This is my support of choice. And I think I'm pretty good at it, but I also enjoy it and Tom feels the same way. But we have -- we've actually -- from a succession point of view, we've built an incredible organization around us. And that's what we've concentrated on over the years to give the folks around us that opportunity to learn the way we learn to have the same opportunities. And so that when the day comes that we do want to retire, we get hit by lightning, the organization doesn't miss a beat. And part of it is, if you're thinking about we've been -- for decades, we've been consistent in how we execute operationally and how we go to market, right? And so the playbook is really simple. It's a couple of pages. And so there's no reason to think that the people that we have hired over the years that have been part of our organization that we have trained, the way we were trained won't just take that same simple playbook and continue to do what we've done. So I feel really good about the group. On the operational side, I'll give you an example on the mill side. Most of the people that are in the senior ranks running the mill organization. They're all chemical engineers with MBAs. And so we've -- we all think the same. We've all been through the same activities. The box plant side now has reorganized over the years. Ray Shirley is a good example. I hired Ray 30 years ago. Ray is a chemical engineers. He's got a Vanderbilt MBA. And when I hired him 30 years ago, and I told him this. I said, you come with us. We're going to teach you more about running mills and box plants than anyone will ever teach you in the world, and you'll never leave us. And so we have this diverse group of younger talent base around us. And so it reaches all the way down to the college well. This year, over the last month, with interns and full time, we've brought in sort of 185 engineers into the PCA North American organization. There's like, I want to say 85 to 90 full time that started over the last month and then the rest are interns and co-ops that are working. And so we're continually rotating this type of huge number of engineers into the organization and off the college campuses for interns and co-ops and many of them end up getting hired. A lot of these young men and women when they come in they might be softwares, and they're coming in for the summer coming in for an interim period of time. If they're really good at what they're doing, and we establish a relationship with them, we send them back to school with an agreement, their tuition, ruling board, all their costs are paid title graduate. If they had debt, we pay their debt, and they come to work for us. And if they choose not to come to work for us they get 5 years to pay us back. Most of them come to work for us. But now we capture them at a young age, and so they come back to next summer and they work again. And so we actually start teaching them when they're 19 years old as an example, and bringing them in. And then also, in some ways, we wean out the ones that aren't just going to make it with us. So we do that early on. And so we have the people that are the young leaders of the future.

That's inspiring and, quite frankly, differentiated from what I hear at least from a lot of industrial companies. So I think that's a really positive thing. Last 1 for you. You have a couple of energy projects, I think, DeRidder, you went garage sailing, I think, is what you said in the past opportunistically -- you talk about targeting at least 20%, I think, IRRs on kind of high-return projects like that or cost savings I don't think you've given us a dollar amount on what the CapEx outlay will be, if you're willing to update us in terms of where those projects are at time line and expected spend?

Yes, as we've done over the decades, we've purchased a lot of steam turbines from those that have been shut down and redeployed them into our assets for pennies on the dollar. We've also done on us with the data center buildout that was taking place over the last couple of years. We needed to become even more independent. And so I located three gas turbines that were at a mill that had been installed a few years back that were not used very much. But these are big 50-megawatt units. So I bought 3 of them and we currently actually decommissioned them to demobilize them and have shipped them to the 3 mills of the Perverville mill in Virginia, the Jackson mill in Alabama and the DeRidder Mill, Louisiana, -- but over the course of the next 1.5 years, those 3 gas turbine installations will help basically create 3 more mills that are energy independent off the grid, give us those type of double-digit return projects. And -- but it gives us well in the with 4 mills that are truly independent of the utilities and self-generating. That's a really huge, huge opportunity. but we'll do it at a fraction of the cost -- to buy a new 50-megawatt Siemens gas turbine today, it will probably be -- just use an example, probably $100 million purchased I bought these 3 gas turbines for $5 million, it presents a good opportunity.

You couldn't get it even if you wanted to 2030.

Yes, it would be 4 or 5 years to get delivered. So we do a lot of things like he said, junk pickers here. But...

Garage sale, not junk. All right. With that, I think it wraps it up. Thank you guys -- appreciate it very much. .

Thanks. Appreciate everybody attending. Thanks.