Smurfit Westrock Plc (SW) Earnings Call Transcript & Summary

Hello, and welcome to the Smurfit Kappa Trading Update Call. [Operator Instructions] And just to remind you, this conference call is being recorded. Today, I'm pleased to present Tony Smurfit. Please go ahead with your meeting.

Thank you, operator, and good morning, and thank you all for taking the time to join us today. I am joined on the call today by our group CFO, Ken Bowles. And before commencing, we would refer you to the note on forward-looking statements set out in our trading update, which also applies to our discussion today. We're very pleased to deliver a strong performance for the 9-month period at the 30th of September with an EBITDA of EUR 1.125 million (sic) [ EUR 1,125 million ] and an EBITDA margin of 17.8%. Our third quarter EBITDA of EUR 390 million is ahead of our expectations and shows the continued strength and resilience of the group in these challenging times. While you'll often hear me say that success is never a straight line, the objective we set ourselves and the broader management team is to deliver secure and superior returns. I believe our results today provide ample evidence that our plans and our strategies continue to work for all stakeholders. What is clearer and clearer is that Smurfit Kappa is today putting itself in the strongest position to be able to serve our over 65,000 customers with our industry-leading smart applications and our innovation capabilities, which are brought to life for our customers through our global network of 27 experience centers. Today, we're able to meet the continually changing complexities of our customers' supply chains, the sustainability challenges and their need to address the accelerating trends of e-commerce and the consumer-led drive towards sustainable packaging solutions. Our performance also demonstrates the benefits of the company's returns-focused capital allocation decisions, our geographically diverse operations, together with our relentless focus on operating cost reduction. As you would all appreciate, this has been a challenging year for many, both in a broad context and within Smurfit Kappa. However, as an organization, we have been able to adapt and learn from these challenges. We have learned new ways of working, remotely where possible and within our operations where necessary. As a consequence, we are further increasing the operating efficiency across our system. And we're currently developing a program, which is designed to ensure that we hold on to those benefits in the years ahead. These significant benefits will be shared in our year-end release. We remain extremely proud of our 46,000 employees who continue to embrace the values of loyalty, integrity and respect and who's dedication has been remarkable in ensuring that Smurfit Kappa has continued to deliver for our customers and their own vital supply chains. To acknowledge those efforts, Smurfit Kappa will be awarding all permanent employees with a unique recognition reward in the fourth quarter. In addition, while not material, we have taken the decision to repay any specific government employment support schemes related to the COVID-19 pandemic. Senior management will be conducting over 250 virtual planned site visits during the restricted period that we're all in. This builds on the success of our employee engagement survey, where we had an over 90% approval for the company's approach to the pandemic. The value of communication and engagement in these extraordinary times cannot be overstated. We've often talked about the transformation of our business and the ever-increasing quality of our people and our platform. Our continued transformation and the operating performance in the first 9 months represents another step towards our vision of dynamically delivering secure and superior returns for all stakeholders. Equally, our significant ESG achievements are also moving our vision forward to continue to be an ever more globally admired company. With regard to current trading, October volumes in both Europe and the Americas have been strong. And while some uncertainty still exists around the evolution of the effects of COVID-19 in the weeks ahead, absent a dramatic change to working practices, we now expect to deliver EBITDA in the range of EUR 1,460 million to EUR 1,480 million. Driven by the strong structural drivers of the consumer-led demand for sustainable packaging and the continued growth of e-commerce, we believe the medium-term outlook for Smurfit Kappa is increasingly attractive. We also believe that we are uniquely positioned to both capture and to capitalize on those opportunities. As a concluding comment, perhaps the best way to express that confidence is the Board's decision to pay a second interim dividend, essentially aligning our dividend payment with prior years. Thank you, operator. We are now to take -- happy to take any questions from anybody on the call. Operator?

[Operator Instructions] And our first question comes from the line of Alexander Berglund of Bank of America.

Well done in the quarter. Just a question a bit kind of going into Q4. I mean you mentioned that you're starting the quarter with strong volumes. And we've seen a lot of e-retailers seeming quite positive into the holiday system. So just now I look at your range in your guidance, and I appreciate that in uncertain times. It's still points to Q4 being a little bit weaker than Q3. So I just wonder if you could kind of give some color on kind of the moving parts here on a quarter-on-quarter basis and also kind of the key points of uncertainty. That's my first question. I have a follow-up after there after that, but I'll let you answer that one first.

Okay. Well, I mean, basically -- Alex, thank you for that. I mean basically, Q4, December is always a funny month. And we're very happy with our October. So far -- I mean, we're only third day into November, but so far -- sorry, second day, finished second day. I think November looks reasonably okay at the moment. But there is a lot of disruption around the place. We've had a number of COVID cases in our factories that are causing us disruption issues over the last 3 to 4 weeks as this pandemic has spread very verdantly across Europe. And that creates staffing issues. It creates risk issues. It creates potential shutdown issues. We had 1 particular facility closed down for 10 days. So we are, as you know, a naturally prudent company and we don't overpromise. So therefore, we believe that's a number we're comfortable hitting. And December is always an uncertain month. And clearly, when you look at the weighting of our earnings, it's more towards corrugated, which operates much shorter month during the month of December than our paper mills. So that also affects things. So we are, of course, prudent as a company, in general, but we believe that we can hit these numbers, and we'll wait and see how they turn out.

I think, Alex, as well, from a pure modeling perspective, keep in mind that there's 2 less operating days in the fourth quarter over the third quarter. That will have an impact also.

And is there anything you could quantify as the effect of those today?

It's about 3% in and around.

Okay. Okay. And my second question is on OCC, which has been quite volatile. I remember like in the -- with the first lockdown that we had, there were some collection issues. I think you had a spike in prices. I wonder like now when we're going in towards kind of a second lockdown in some European countries, do you think that kind of the industry is better prepared this time around? Or is there -- that there's risk now we got another spike upwards on OCC?

I think there's always risk on OCC, either which way. I mean, we would have actually been expecting it to be going down in November and December as the Chinese were stepping out of the markets. But in actuality, because of the strong demand across the piece, so to speak, there is good demand for OCC across pretty well every market. And that's kept the prices stable or even edging upwards in certain markets in the last 6 weeks or so. I would say that I don't -- at this moment in time, we don't see the lockdown to the same dramatic effect as the last lockdown. So there is still -- there are more businesses operating. There are -- there is a sense of more normality this time around than last time around. We -- so we don't necessarily see the supply shortages right now. But as I say, December is a very funny month. And there could easily be a spike in OCC. We're just -- we're not calling it right now. If the spike hits, it will more likely affect the second half of December rather than the first half. But it's really an unknown situation for us, Alex. You see certain markets like Brazil that's really zoomed up. But in European markets thus far, it's relatively stable at a higher level than we would have anticipated.

Our next question comes from the line of Lars Kjellberg of Crédit Suisse.

Again, a very strong performance in the quarter. You mentioned, Tony, that was above your expectations. Could you share with us what surprised you? And kind of if we have some sort of bridge how, again, went from EUR 355 million to EUR 390 million. And also your commentary now on strong demand trends. You announced, of course, a EUR 50 price hike for testliner, and we got EUR 13 in the published price indices. Is there good enough momentum to get any more of that EUR 50 announced in the current month? Those are my 2 first questions.

Yes. On the second question, I'll let -- maybe let you take the first question on what surprise us. But on the second question, Lars, the demand trends are very strong, pretty well across the world. Paper is in extremely short supply. I do believe it is our strong belief that the second EUR 20 of the EUR 50 will go through in November. Certainly, all of our suppliers are indicating that to us. We believe that we would get a good portion of the kraftliner increase through in November. So it will be effective really all of December. So the demand trends remain strong, and I would say a full implementation of the EUR 50 will happen in November. So I think that's positive, obviously, for box business as we go into the first half of next year.

Lars, I think, firstly, we talked a bit at the half year around a bit of softness in the box price coming into the third quarter and the fourth quarter. We didn't necessarily see any or all of that in the third quarter. So a bit of positiveness there. I think the other piece, quite simply, is really on the cost line, the way the business is handled and continue to manage that. It's that kind of constant relentlessness around making sure that we focus on not just 1 line in the P&L, but all lines in the P&L. I think we did that kind of -- we did fairly healthily across the year, and indeed, continue in the third quarter and continue on like that. I think probably the most pleasing aspect of this was maybe the performance of the Americas division. They really had quite a strong third quarter, and indeed, October for a number of countries has continued in the same vein. So I think it was the case of -- we sort of -- we understand how we operate internally. I think the guys that continue to deliver at an operational level and particularly keeping that, if you like, that relentless focus we've had on serving the customer, bringing the innovation to continue kind of focus on sustainable packaging, but quite simply, doing all the things we continue to talk about. But most pleasingly, I think, for us, given the geographies, I think the Americas had quite a strong third quarter and certainly a strong October.

Got it. And just to be clear then, in your guidance, I guess, testliner, you're in a short position in Europe. So you've kind of included that as a moderate headwind, I suppose, I mean in your guidance for Q4 before we started to move that into box prices. If you can kind of confirm that? And the second one is -- I appreciate it's very early days, but can you give us any sense of the benefits you're talking about in terms of the change in the working practices, et cetera?

On the second point, no, we would rather wait until we get to the year-end because we're still working through certain issues. But on the first point...

No. I think it's probably built into some of the conservatives too, Lars. The reality is any impact on box price is a '21 event. So we're not there yet. But we'll sort of manage that in and round I think as we see it come through. So not necessarily impacted on the range.

I mean since we bought Reparenco, Lars, we're not as short as we were. We are short in certain areas, mainly kraftliner -- sorry, we're long in kraftliner, but we're not as short as we were in recycled paper. Obviously, the more we grow the system, we're not adding a whole lot of capacity in our papermaking operations. So the more we grow in corrugated, the shorter we'll become again, and that will obviously give us a strategic advantage at some point to plug that hole, but it's not now. We're not over short. So it's a minor headwind, but nothing significant.

Our next question comes from the line of Barry Dixon at Davy.

Well done on the quarter and the year-to-date. A couple of questions from me. And it's really a follow-on from last question there, Ken or Tony. The margin, if I'm not mistaken, was an all-time high at 19% EBITDA margin for the quarter. Can you give us a sense as to the sustainability of that scale of the margin? Are we now at kind of in a new sort of margin environment for the group driven by a whole host of factors like the medium-term plan and the cost savings program, and that relentless focus on price-cost management, I suppose, is the first question? And if so, what -- can you give us some sense as to what that sort of through the cycle margin might look like? The second question really is in terms of pricing and delighted to hear that pricing is going through. At what stage do you think this will sort of feed through into box prices, if at all? And I suppose a related question on the pricing. Are you seeing any impact -- the market seems to be very tight and so -- which is maybe surprising, given that there's a couple of new mills coming on stream. Are you seeing any impact in terms of those new mills coming on stream? So those 2 questions, please.

With regard to margin, I mean, one of the things we're at pains to point out, Barry, and I know it's very hard to model, is that when you look at our volumes, sometimes we're reducing our volumes to our customers because we're changing the basis weight of the company -- the packaging through innovation. And we're getting higher margins, and we're giving our customers lower prices. And that's a continuing trend across the company. So the whole innovation development of the company over the last number of years and the focus on innovation is what is really allowing both our customers to win and ourselves to win because we are redesigning packaging. We're making smarter packaging. We're making more effective cost savings through the system for our customers as well as sustainability savings. And that's allowing us to ensure that we're giving lower prices and ensuring that our margins are at an acceptable level. And that trend will continue going forward because our applications are far and away the best in the industry. I mean others will talk about their application has been good. But when you look at the way that we have collated all of the knowledge that we have through modern technology, and we're able to transfer that. And now in these current times being able to transmit that to customers electronically and work with them electronically because of the restrictions that are out there, it is really a huge competitive advantage for Smurfit Kappa. And so where the margins are through the cycle, it's really hard to say because obviously, it moves with wastepaper, it moves with paper, it moves with the timing of implementation of price increases or price decreases. But the only thing I can say for sure is that there is a structural movement upwards over time because of innovation and knowledge that we have. Otherwise, we shouldn't be investing in it. We should be just a brown box commodity producer, which we're not. We are a merchandising medium for our customers, and that's where we intend to stay. And it's what our customers like. And then you add on top of that the whole area of sustainability trends and the replacement of plastic. It does give us very big opportunities to continue to give our customers something different and at the same time ensure that our margins -- and ensure that we get paid for it adequately for a good period of time. Ken, on the other point on pricing?

On the testliner price increase, Barry, I suppose it's important to recognize that the safety it has gone through now kind of restores the drop, if you like, that happened across the summer. So in the near term, we'd expect it to be a support to the box price rather than, say, any incremental box price increase as we go towards '21. We'd have to see how things evolve to kind of get to that place. And then on the tightness in the markets, it's interesting. We started off the year with inventories north of 800,000 tonnes. I think as we sit here today, with probably 4% extra production year-on-year, we're sitting inventories well kind of towards that kind of tight range of south of 700, but north of kind of 650, 660. So inventory is definitely tight, demand for paper high, as we know, from the pull-through to our corrugated division. So if you like, that's the sort of backdrop to what we're seeing on the price increase and the success of it.

Okay. And just to follow-on to that. I mean, it certainly sounds like we could be looking at a -- moving into a pricing up cycle, albeit maybe a mini up cycle, but certainly a pricing up cycle, but starting from a very high-margin base. Is that a fair characterization or not?

I think we don't like to forecast the future in that way, Barry. We're just -- we just live in the present to make sure that we deliver for our customers. And then obviously, we have been surprised at how quickly the market has tightened across the world. I mean we are shipping paper from Europe to our Americas business because of the shortages that are out there at the moment. We were taking downtime in June in our Colombian paper mills because we didn't have enough orders. And now we don't have enough paper to -- we just don't have enough paper in the system. So you can take your own view on that. Our view is just to make sure that we supply our customers with the boxes and have the paper available, which we've been just about managing to be able to do for the moment.

Our next question comes from the line of Justin Jordan of Exane.

Well done on a stellar Q3. I just want to explore the improving volume environment a little bit, please. Can you just confirm that -- it seems like volumes have sequentially accelerated each month as you've gone through Q3. And you talk about a strong October. Can you just quantify what your organic volume growth has been in October, please, in Europe and Americas, firstly?

Justin, it's Ken here. In terms of volumes, we saw kind of progression through the quarter. So if you remember at the half year, we probably talked about July being sort of flat to maybe down 1 in the round. August is a plus 1 and September plus 2. So when you kind of put that all together, you probably end up with a, call it, a plus 1 for the quarter. As you move into October, for Europe, we're seeing kind of volume growth of, call it, 3% as we exit October. In the Americas, that October number looks close to 5% to 6%, again, coming off a slightly lower number as we go through the quarter for the Americas. We're certainly seeing -- without predicting what November and December will hold given what Tony said earlier and indeed in the script, certainly, we did see acceleration through the quarter, and we've seen a strong October.

Fantastic. And just following up on that. I'm trying to understand, clearly, anyone that's there in the sector is familiar with very strong e-commerce growth, and you're one of the leaders in e-commerce in Europe. And clearly, also sustainability is a tailwind. But I'm trying to understand within, let's say, that 3% organic growth in November in Europe. You're probably still seeing industrial being at best flat or I'm sure probably negative year-over-year. So where is the strong positive surprises? Is that in food packaging? Is that where -- I don't know, eating more from super markets, eating less in restaurants or something? Or is this a Smurfit Kappa contract win thing as opposed to an industry-wide thing? I'm just trying to understand what's going exceptionally well for you.

I think -- Justin, it's Tony here. I would say that there are some very big trends moving in our favor. I don't yet subscribe to the fact that sustainability is a big trend in our numbers yet. I mean there's a myriad of products -- projects out there that we're working on that could turn into very large numbers for us at some future date, not even next year because by the time our customers reengineer their packaging lines, it just takes a long time. But there is a lot of potential still on the sustainability area to come. I think what's happening is that you can just look at the savings rate in Europe for everybody, and people are not traveling and they're not -- they're not having away holidays, and they're spending a lot of money on their homes, and they're spending a lot of money at home. And that has a lot of packaging associated with it. And that is obviously, one of the factors that's driving it. I think there will obviously be some shift back if the -- if magically -- which we always hope for, if magically the world would come to normal again with regard to COVID. But equally, then you'd see a lot of pent-up demand, I believe, potentially for some of the more industrial products such as cars, which have recovered over the last -- car sales have recovered over the last month or 2. So you're going to see some pent-up demand in that area that will address some of the shortfall that we've had. So I think overall, unless you have a very deeply negative view of the world because of COVID, I think we're in reasonably good shape because of some of the structural drivers, a, you mentioned e-commerce, which is going to continue, b, the future growth of sustainability, and then c, I think, what's happening right now with regard to being at home, and that there's not a lot of money available to -- I mean we see big demand for TV sets, boilers, kitchens, whatever you want to name it, that all have boxes around them.

Our next question comes from the line of David O'Brien of Goodbody.

Firstly, just on -- look, I guess if we step back and look at 2020, you've served customers extremely strongly, given notwithstanding the disruption we've seen across markets due to COVID by your own description. You're talking about best-in-class applications within your product offering as well. Now I know you've told us before that new customer wins take time to come to fruition. But I guess what I'm asking is could 2021 be -- you see market share gains accelerate just given the strength of your service levels into customers in 2020? Like how is your business development pipeline panning out at the moment? And are you going to see any volume benefits to such high level of service in 2020 going into 2021? And then, secondly, just on capital allocation, obviously, extremely encouraging to get a second interim dividend, which is the only company in the sector doing so. I guess, how do you step back then and look out? Your balance sheet is clearly very strong. How do you weigh up the different options you have for capital allocation? I know you've got the efficiency plan you talked about next year, but how are you looking in terms of M&A opportunities? Is the kraftliner mill back on the table in South America? And just how are you feeling the whole capital allocation piece?

I'll let Ken take the second question, Dave. How is the business pipeline? I think as we came into this year, we had a very, very strong business pipeline and really no particular customer losses to be feared. And that -- a lot of that was put on hold during the first half for the reasons we all know. We've developed that out as we go into the second half. I think the pipeline is strong. We don't expect to have any major losses. We are in negotiation with a number of larger customers. But as you know, there is no customer that has more than 2% of our overall business. So I mean, in general, we've secured the vast majority of our business going forward. And we have a number of large potential developments with many large customers to either convert from paper to -- from plastic to corrugated or indeed to take some share. But those in COVID times take a little bit longer to actually action, which is a positive, if you're on the threat of a particular business. But it's a negative if you're winning business, and that's what we certainly saw during the first half of this year that it took longer for us to implement. But one of the great strengths of Smurfit Kappa is that we have people in every territory. So where we need to actually do trials and work with the customers, we can have local people on the ground, boots on the ground, so to speak, to work with the local facilities of our pan European, our global customers to be able to implement new volume. Whereas if you're a single operator or a smaller operator, that's very -- in these times, it's incredibly difficult to do. So I think again, another slight strategic advantage to us.

Dave, on capital allocation, so if we sit back and think about it, on average, this group delivers call it, circa EUR 1 billion of allocable cash flow on an annual basis. So free cash flow and free cash flow beneath that has always been a kind of strong strength of the group. So then when we think about that, we've always -- internal investments in our business has always been a priority, and we've done that fairly consistently and used that to kind of either drive efficiencies or incremental returns, and you can see that the return on capital employed over time. Once you get beyond that, then you're kind of into how you allocate your free cash flow, and really, that comes down to 3 things for us. That's with M&A. It's about attending to the balance sheet and make sure that stays in good shape, and we've done a lot of work in that space, as you know. And then the dividend, and the dividend is very much a key part of our investment thesis. It's very much input rather than output of our capital allocation discussion and decision. And I think that's what you see in relation to the second interim today. When we sit back and look at the strength of the business, the prospects going forward, where we sit in terms of cash flow for 2020 and how we feel about the balance sheet, there really is no reason not to pay that second interim dividend. I think that's -- so we always do things from a position where we believe we're strong. And that's what we've done again today. So for us, it was important to recognize that all our stakeholders are stakeholders. And while we -- internal investment for 2020 has been quite strong in the business, also important to recognize that our shareholders have a part to play in that, too. So we're delighted to be able to kind of pay the, if you like, the deferred final and ever more pleased to pay a second interim too.

Our next question comes from the line of Kevin Fogarty of Numis Securities.