Packaging Corporation of America (PKG) Earnings Call Transcript & Summary

Our guys kicks up. We got a Packaging Corp of America. We're excited to have the team here. Representing the company, we've got Mark Kowlzan, CEO and the CFO Mark, do you want to kick things off? Just give us a sense of what you're seeing out there?

Yes. Thanks, Phil. And as usual, I've got probably limits of prepared remarks that I want to go through, and then I want to spend more time on the fireside chat piece of this. But as usual, we will go through a presentation. We're not going to do the slide-by-slide review. We've posted the presentation on the website, and I have hard copies available if anybody needs anything. Before I begin, I do have to remind you about forward-looking statements disclosure in the presentation. The statements are made as of today, and actual results could differ materially from any expression in any forward-looking statements. Again, I don't have nearly as much to say as when we were out on the road in the second quarter. So far, 3Q has progressed consistently with what we called out in the July earnings call. We continue to see very tight containerboard market conditions, and we're in a much better inventory position than where we were coming out of 2Q. We had all of the outages going on during that period of time. We continue to run incredibly well. We've had excellent operating months now in the mill system in July and August with no maintenance outages or any other meaningful interruptions. And so we've been able to restock our inventory. We had a tough early part of the year trying to take care of our box plants and our customer needs because of the outages and the strong demand. And then where we are right now, even though we're running well, we need to rebuild continuing into the fall right now because we have a significant outage schedule ahead starting actually this month, we've got one of the containerboard mills down. And then 4Q, we've got mills down. And so again, and that's against the backdrop of stronger corrugated demand as we go through the holiday season right now, and that's what we're seeing. Through August, we're on track to meet or exceed our third quarter earnings guidance that we called out in the July earnings call. Costs across the board are favorable to forecast. We took the elevated freight and recycled costs that we're experiencing into account when we built the forecast. So we did anticipate that diesel as an example, OCC, some of those elements would probably continue creeping up. So our forecast and our guidance that we gave on the July call did take that into account, and we're glad we did that. We've done an excellent job implementing our packaging price increases, and we're ahead on forecast in terms of price realization. We are below our initial expectation on corrugated volume. Think about this, due in part to the expected sales in the ag sector with the drought and then crop effects. Everybody knows most of the news coming at us on a daily basis through a lot of July and August was about some of the ag products and what it was doing to people. So again, it's been a tough ag summer. And then just the ag year, Florida had a tough winter. They never recovered. The Pacific Northwest, as an example, the Apple crop, cherry crop, those were not as big as the expectation. So Ag's been a drag on us. But we're still having a strong quarter. but we're just off slightly from what we guided when we talked on our July earnings call. But still, if you put it in perspective year-over-year with the Greif acquisition, we're up 24% over last year with Graft were down just slightly from what we do to be because of primarily ag and farm related activity. And then last but not least, white paper. We're having a very good quarter across the board in terms of sales volume, price and mill operations. And then kind of summarizing when you are thinking about us for the rest of the year, I want to remind everybody containerboard markets remain tight, and we continue with the lower export shipments. Corrugated volume seasonally improves, but mix seasonally gets weaker just the nature of the business, more e-commerce. And so -- but again, volume remains strong in that regard. Corrugated volumes are seasonally improved again because of the mix changing. And that's truly just the e-commerce effect of what we always see, and it starts in August generally. We expect price improvement from the continued implementation of the earlier price increases and the beginning of the realization of the most recent price increase in corrugated later in the fourth quarter. We'll resume our outage schedule this month, as a matter of fact, with the Riverville mill and International Falls, which is a white mill going down this month. And then DeRidder, Valdosta and Massillon mill will be down in Q4. Consistent with what we told you on the earnings call, the earnings impact of the outages is about $0.30 to $0.35 on higher sequentially 4Q over 3Q. And that's, again, just the nature of the accounting with the work we do. We continue to see elevated freight and recycled prices. The question remains how elevated. We'll obviously have more insight into that when we talk to you in the October earnings call. We'll also get seasonally higher input costs in the mills as the year goes on as the weather simply gets colder. You're always using more energy, more fuels has fall rolls on into the November, December period. White paper should sequentially improved with the completion of the 3Q maintenance outage. So September is the annual outage at I Falls, so this 3Q in the paper side of the business when we report earnings, people are going to wonder, again, the earnings were down in 3Q, but it was just the effect of the outage that we have. We won't guide for 4Q until October, but we remind you that 4Q is normally lower than 3Q in terms of earnings due to the outage impact and mix effects as well as just higher input costs, as I mentioned, with seasonality. Assuming freight is within reason, this year should not be as pronounced as last year with expected price improvement partially up offsetting the cost factors. And with that, Bill, we'll turn it into Chat.

Lots of impact there. Mark, on the demand side, Ag season is obviously heavy in July, August. Is it less of a contributor in September? And outside of bags, it sounds like box demand overall is still pretty healthy. Just give us a little perspective on what you're seeing outside of the well document salad a dynamic that did have some jokes demand overall?

Yes. Again, everything we've seen with some of the our volume being slightly off was really related to the ag and what happened with the impacts of, as you just said, lettuce in particular, some of the other food crops. But the rest of the business is strong. We've seen a huge impact with e-commerce picking up in August, and we expected that. And so in general, across the board, if you think about our customer base, we're still seeing very, very strong demand with the pricing activity that we're currently going through. I do want to point out, and we've said this before publicly, we will give up customers when it comes to price, we'll walk from some customers if that's what it takes. We're not going to deal with certain matters in that regard. And so that's a little bit of the volume impact, but very slightly. But I'm feeling really good with where we are in spite of the world we're living in. If you think about the consternation on a daily basis around the world, our volume is very strong. Again, I've used this on the July call, Tom and I talked about how tight the market is. I'll still use that word today. Containerboard availability is tight, you cannot go out on the market and buy tons. And so we're fortunate where our mill system is running incredibly effectively and efficiently. We've talked about this back before we feel about our recapitalization over the last decade. We got ahead of the curve, and we have the most efficient mill fleet and the most efficient converting fleet in the industry. in North America. And so we just have to plug and play right now. We started up our new box plant in Ohio, actually about a month ahead of schedule. So -- so the new plant in Ohio is up and running, and that's our biggest plant now to date, and we're incredibly pleased with what -- how that performance is looking. So we're in a good place.

And a touch slide, just to be clear, Mark, you're still talking about pro low to mid-single-digit growth, right year-over-year. Perfect. And then you talked about how typically earnings sequentially usually dips in 3Q to 4Q. That's just historical seasonal trend. Is there any other consideration we should think of just given the junior increase back flow through dynamic is pricing kick in more so that trend is less relevant this year perhaps.

Yes, that is a help, and that's going to help counteract some of that sequential to 4 normal decline -- so last year, we were about $0.45 difference between 3Q and 4Q, if you take Graf out of the equation. Okay. This year, bad guy would be freight recycled that might go against us, but price should more than offset that. So I think we'll be a little better than 45 different So.

Okay. And any traction in September increased probably wouldn't have much contribution in the fourth quarter.

I might kick in a little later in the quarter, but

Okay. Okay. Helpful. You used the word tight market conditions, right? When we look at the industry data for 2Q, operating rates were the mid-90s and inventory came down dramatically. How do you kind of see that playing out the rest of the year? I mean I'd love to get your thoughts in terms of your backlog and your -- how extended as it is through back half this year.

Yes, we're running full. If I had to come up with another ton, I don't know where I'm going to come up with another ton of containerboard. The middle systems are running our PCA 9 mills are running incredibly strong. The Greif acquisition, the Matalan Mill in River on the on -- think about that we just passed September 2 last year, we closed the deal and so within a year's period of time from the accretive opportunities and the integration, we've added probably 160,000, 150,000 tons of production on an annualized basis. And I'll give you an example. When we closed the deal, the 2 mills on an annual basis, we're producing probably 650,000 tonnes a year. We're over 800,000 tons a year run rate on both those mills right now. And so they're incredibly valuable to us. They're incredibly necessary to supply our own internal needs. And so go ahead, Kent.

Yes. Let me interject too. Remember too, we did the Wallula restructuring at the beginning of the year. And we're just going to be catching up with the effect of that from a supply standpoint from 4Q, 1Q. So -- and add in another outage in 4Q, so tight is the name of the game right now.

Okay. Well, maybe on that note, Ken, some of that transition from Wallula and debottlenecking Help us think through availability capacity in 2027 to meet demand and perhaps thinking bigger, longer-term picture, mark as well. What are some other views you're thinking about in terms of debanking capacity?

I'll start, and Mark will go into detail on this, okay. So we'll get a little more out of Jackson next year. The wind -- the winder project was scheduled to add about $1.40 on an annual run rate basis in. We probably have a little bit of that going right now. We've run Jackson a little better than we thought, but there's still a little bit more to come there.

That winder should start up next month.

Yes. counts has a couple of projects in the hopper that will get 30 to 50 out of it in the next, call it, years. And then Mark alluded to Greif continued reliability and efficiencies and debottlenecking there. So there's a little more gas in that tank as well.

Any other bigger projects that you guys are thinking about that can unlock further capacity?

I want to talk -- it's interesting. We have studied and looked at everything, including new paper machines. But the cost of capital is so high that -- and you've seen this in the industry, but specifically, I could not justify putting in a new paper machine as well as we do things and as good as we are in engineering and installing a lot of our own equipment, the cost of these capital projects has increased so dramatically, and I put it in perspective in this regard. . Since 2017, we spent $6.5 billion in the mills and box plants. Significant amount of that went into box plants. If I had to start doing that today, with what I accomplished from '17 until now, the cost would probably be $10 billion to $12 billion because of the inflationary impacts of all of the capital equipment. Think about what copper prices copper, all your electronic components, steel, all of the alloys, all of the manufactured components that go into heavy industry. So it's an incredible challenge right now, but we're in a good place. So we don't have to recapitalize. We just have to maintain what we have and then we will put on -- as we grow with our customers, we will bolt in new converting lines and we'll maintain the converting lines. But we're not in a position where we're having to try to revitalize our fleet and our mills are running an incredibly efficient manner because we've taken care of them for 30 years. And so we just have to continue doing what we're doing. And part of that is the organization we have in place. We have probably 200 people in our corporate technology and engineering organization. The mills are heavily staffed. The box plants are heavily staffed now with engineers. And so we're in an incredibly strong position to continue just doing what PCA has always done, just to stay ahead of the curve.

On that note, the fear for this industry has always been at least the last 2 big runs in terms of the e-commerce growth was capacity coming on, right? The book man is we're going to convert some newsprint mill, uncoated free shape mill. But to your point, the cost of capital to build that has increased dramatically and even the integrated guys are in the marketplace. Mark would love to get your thoughts in terms of does the industry at large need to recapitalize the asset base, whether it's mills or box plants. What does that mean? I mean you think that's the fear, right? The bogging men is pricing is awesome. This is going to attract a lot of capacity. That's going to ruin the party. But I mean you made the point, everything costs a lot more now.

The cost to enter this is so extraordinarily high now. if you think you're just going to build a mini mill, we're going to sell your product to them. The cost to build that meaning mill is so extraordinarily high that unless you have already customers lined up and on the box plant side, you have customers lined up. But if you build a mini mill, you have to build box plants. And box plants. The box plant we just finished in Ohio was $275 million. Ten years ago, you built a box plan of $50 million.

And Phil, your recycled mini mill that he's talking about is well north of $1 billion now.

Yes. 10 years ago, you could build a mini mill for $400 million. I want to put this in perspective, too. The last big integrated containerboard mill that was built in America, it was built in 1983 at a cost of $500 million. If I had to build that mill today, that was built in Louisiana in 1983, they're probably $9 billion to build that mill capacity out. So people talk about capacity and the cost to enter this. So that's our -- I look at that, that's our barrier to entry.

And there's a time factor on this as well. It's a multiyear project. 3 or 5 years.

Even if you were -- if we said we were going to build just a mini mill, just an OCC-based mill, 4 years, if we had all our engineering done and we're ready to place orders, you could probably get it done in 3 years. But if you going for permitting, engineering and getting quotes you're probably a 4-year process. And at the same time, prices are escalating. So -- so again, I think that's probably the best barrier to entry that we're looking at.

Are we at a point in terms of the mill network and Box Network for the industry at large. We're at a recap point? Or do you have any perspective on that front?

Well, again, I think the individual companies got to deal with what they have to. You -- you're not going to survive in terms of -- I came to PCA 30 years ago. We had 4 mills that were old. We had 39 box plants that were old. So over a 30-year period, we've consistently focused on recapitalizing making the mills run better and better and really extracting all the value we could out of these assets. Same thing with the box plants. People forget this, we've made since I've been running the company, we've made probably 29 acquisitions, Kent.

20-something.

Yes. It's up 28, 29 acquisitions. And so we're running, I think, with the Greif acquisition, probably 95 box plants today, converting operations...

Low to mid-90s.

And at the same time, we have shut down probably 30 box plants over the last years, 17 years. So we've rationalized and focused on what we need to do, grow out our business in a very effective manner. And -- but again, this -- the cost to be in this business, the capital cost, and this is heavy industry. And people -- it's amazing when we have these discussions, people really don't appreciate what it costs to be in this business. It's no different if you're talking about steel mills, aluminum smelting pulp and paper mills, converting operations. This is incredibly capital-intensive. And so...