Smurfit Westrock Plc (SW) Earnings Call Transcript & Summary

Welcome to the Smurfit Kappa Group 2021 First 9 Months Trading Update. [Operator Instructions] Just to remind you, this conference is being recorded. Today, I am pleased to present Tony Smurfit, CEO. Please begin your meeting.

Thank you, Mark, and good morning, and thank you all for taking the time to join us today. I'm joined on the call 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. Please also note that Ken and I are calling in from separate locations, so please bear with us should there be any technical issues. I'm happy to report that Smurfit Kappa continues to deliver across all performance measures, with revenue growth for the 9-month period of 15% to EUR 7.287 billion, EBITDA growth of 10% to EUR 1.235 billion and a margin of 17%. From a demand perspective, we remain effectively sold out. Continuing the trend of the first half, the group has year-to-date corrugated growth of 9% in Europe and 11% in the Americas versus 2020. Interestingly, set against 2019 as a comparator, the group had a corrugated growth of 9% in Europe and 10% in Americas. These growth levels represent a demonstrable step change within our industry. As I've said before, our product is increasingly well-positioned in a more sustainable world, being renewable, recyclable and biodegradable and, in certain cases, reusable. In addition, e-commerce is now a feature of our daily lives with the pandemic accelerating and already established channel. Similar to 2020, 2021 has been characterized by the security of supply concerns. In Smurfit Kappa, I'm proud how we have worked relentlessly to ensure our customers have experienced limited supply issues. The year has also been characterized by rising input costs. When we spoke to you at the half year, we indicated that recovered fiber headwinds would be approximately EUR 450 million in 2021 over 2020, which remains unchanged. At that time, we did not anticipate the sharp increase in energy costs. The group has a continuing hedging policy in place that will limit this additional cost to approximately EUR 80 million in the second half of the year, resulting in a EUR 180 million increase in costs year-on-year. These input costs have led and will lead to further paper price increases, which are being recovered through our corrugated system. Nevertheless, we still anticipate delivering significant EBITDA growth in 2021. To strengthen SKG's market leadership and to meet growing customer demand, in the first 9 months we have approved some EUR 600 million of capital projects across the group. Through our recent capital investments and paper acquisitions, we believe our European mail system is now capable of offering security of supply and supporting customer growth for the next few years. During the year, we have approved 48 new converting machines and 6 new corrugators across our markets in our converting business. This demonstrates our continuing focus in our conversion capacity to develop the many, many significant opportunities we have to provide our customers with security supply, with value, with innovation for the sustainable packaging in the markets in which we operate. We're also delighted to extend our geographic reach with recent acquisitions in Mexico and Peru. What should be clear to those of you who that have been following Smurfit Kappa is our commitment to sustainability. That commitment is both from a product perspective and the manner in which we produce the product. The group has also aligned its sustainability additions and targets into its financing. Firstly, by embedding its targets by a key performance indicators into its existing EUR 1.35 billion revolving credit facility, creating a sustainably linked RCF and more recently through the launch of the group's green finance framework and the issuance of a EUR 1 billion in green bonds under that framework, EUR 500 million at 0.5% and EUR 500 million at 1% with an 8- and 12-year maturity, respectively. These are the lowest coupons in the group's history and indeed in our rating category. My concluding comments are and have been pretty consistent through the year. While input costs have risen to levels that are both unprecedented and unexpected, current industry conditions are very strong. Today, we see numerous opportunities across our business which we are investing in from a position of enhanced financial strength. Even against that backdrop of significantly higher input costs, we expect to deliver EBITDA growth in 2021, in line with current market expectations. I am very happy to say that Smurfit Kappa has never been in better shape, and I'm very excited about the opportunities and prospects for our business. Thank you, operator, and we're now happy to take any questions.

[Operator Instructions] And our first question comes from the line of Lars Kjellberg of Credit Suisse.

Thank you, and good morning. A couple of questions from me. First and foremost, can you comment on your trajectory for pricing in Q3? I think you mentioned 5% up in the second quarter. And then I want to just segue into the growth that you mentioned, Tony, kind of EUR 600 million that you've approved year-to-date. How much of that have you actually spent already? And what sort of contribution should we expect from the investments now approved in 2022? And that's all, of course, you just closed the deal, I guess, in October. Can you share with us the economics near term, but equally, so how you think about that mail into your system and the overall contribution you'd expect in '22, '23, as you fully integrate this mill and expand the capacity added?

Okay. I'll let Ken take the first one, but let me just talk about Brazil for a second. We -- let me say I've been there twice now, obviously, before the acquisition and just recently last week. And I have to say that the mill is truly world scale. It's a fantastic mill. Obviously, the position that they are in an energy is going to hurt them a little bit in the first month or so because energy prices are so high and then not hedged at all. So they will need the price recovery, which is going through to start making decent money in mill. And obviously, we've adjusted many of the prices that, that mill was previously selling that. So as we go forward, we remain hugely excited about the potential. It fits us like a glove, down to our southern markets, Spain, France and Italy, where we are very short. We're also short of paper in the Americas. And so the Savona port when the container situation eases up is an ideal shipping area for us. So it will be a very large contributor through the cycle mill for us given its scale, given its opportunities -- given the opportunities we have to reduce the cost and given the fact that we will integrate not everything out of the mill because we will keep out some outside customers. But we will -- we see a huge opportunity in the mill this year, next year and going forward because it will run around 500,000 tonnes towards the back end of next year, and then we'll make some capital investment to get it up to the 600,000. With regard to the growth, the approvals, Lars, as you could probably appreciate, very little of those approvals will be benefiting this year, almost none because the length of time get machines, given the market conditions is anywhere from 9 months to 18 months, depending on the kind of conversion machines we're talking about. But we should start seeing some of the benefit into next year, but the full benefit of that will probably come into 2023, as we ramp up the capacity onto those machines. We should expect to get most of those 38 machines into the system next year. But the benefit will be during the year to some small extent, but really into 2023 will be the full benefit. With regard to pricing, Ken?

Lars, as we would have talked about at the half year, sequentially, Q2 and Q1 was 5% on the same basis. Q3 over Q2 would be 7%. And then in terms of overall CapEx in the context of the 600 approvals, we're still looking at a full year CapEx number in that kind of EUR 750 million to EUR 800 million space. And as Tony says, in terms of what that means context of '22 and beyond, we'll hang on until we do our budgets and until we will chat with you again in February.

Just one short follow-up. On the growth prospects for next year, of course, this year has been extremely tight. You've recently over the past couple of weeks, announced a couple of sort of plastics replacements, packaging solutions. Can you give us any sense of what you're seeing in your pipeline of sustainable packaging and potential plastics replacement and new business in next year? And do you have room to take that on?

Well, we will have room to take it on. Lars, I'd say that we still see customers hugely engaged in even as those of yesterday we had a large customer looking to take on some of our innovations in replacement of plastic hubs into corrugated. There's one fundamental issue right now is that most companies are really fundamentally worried about supply chain in getting their existing products into the shops. And so I suppose the urgency level at this moment in time is not as it was, let's say, 2 years ago, pre-pandemic, and everyone's going to do it. Everyone is committed to doing it. Everybody wants to do it. But at the moment, many of our customers' #1 priority is, a, get supply, which I have to say that we have, for the most part, being really good at. I mean, we are not their problem, and that has given a huge positive edge to Smurfit Kappa as we go forward, that people will see us as the secure supplier of packaging when many other companies are letting them down. The acquisition of the Verzuolo mill, again, assures our customers and many have commented to me about it that they're sure that we're continuing to invest in capacity, so that we can meet their growth. And I think that from the future forward looking for sustainable packaging is going to be I mean, as big as we thought or if not bigger. And I think the whole event of this week around COP26, again make sure that sustainability is top of people's mind. And -- our products, we have the right product in the right time for this. And so I see nothing, but optimism in that whole area. And the recent announcements as small as they are, are just continuing to build on the pile of sustainable projects that are coming forward.

The next question comes from the line of Allan Smylie at Davy.

I have two, please, one on demand and one on box pricing. So it seems like demand is very strong again in Q3, and it would be helpful to get just some color on demand trends across your customer base, so FMCG, industrial and e-commerce through Q3 and how that feels into the fourth quarter? And then on box pricing, I had a specific question around the mechanics on how you're dealing with energy cost inflation because we're seeing obviously a number of paper producers adding energy surcharges, I'm just wondering how that phases through to your index business? Is that just a lagged function still of paper prices? Or do the energy surcharges also feed through?

On the demand side, you can take the pricing, Ken, -- on the demand side, I wouldn't say I could be very specific about where is really good and where it's really bad because it's all really good, Allan. I mean we are seeing some sectors slightly -- slightly -- somewhat affected by the chip shortages. So for example, television manufacturers are car component suppliers, who are not suffering, but they've slowed down because they can't get enough chips to -- the carmakers kind of get enough chips. But that's around the edges. I mean, it's been more than made up by all the other sectors, FMCG, e-commerce, all the projects that we have, all the innovations, normal demand, reopening trade for many restaurants. So we don't see any -- you might see a blip in a particular factory that we have because they're more reliant on heavy-duty packaging for cars are that you might see a television guy factory. But in the round, we just don't see anything. And indeed, in some countries, like Colombia, demand is completely excessive at the moment. With only one weak country, and that's Brazil, it's been weak for the last 5 or 6 months, but seems to be improving each month and now with the current stimulus that the government is talking about putting in, again, we expect that to reverse, but our results are still very good there. But the only weak country, I would say, that we have not necessarily excess capacity, but where we could do with a bit more work is Brazil because we've been putting in some investment there to part of the growth. So overall, I couldn't give you a -- any area other than around the edges that is suffering. Ken, do you want to take the box pricing issue?

Sure. Allan, I suppose the surcharge model is necessarily a function of our own pricing model. I suppose to answer your question in a short way, yes, it's just the energy cost is a normal kind of lag recovery into boxes because you will have seen price increase, particularly, say, for the first November price increases of 60% on both grades, is predominantly, if not all, to recover energy costs. And that will naturally feed into the calculation of the index and therefore, naturally feed into the calculation of box price. So more than to be fair, later case 2, which have been recovered around the edges. So if the focus is not just necessarily in OCC, but also energy and all inflation costs to be recovered through the box system.

Yes, I think, Allan, it's important to say that our business is in a sold-out position primarily everywhere. And obviously, in that position, we are making sure that we recover as much as we can. Obviously, we have some contracts, which we'd rather not have in an increasing market. We -- but you have to live with those for 6 months a year or whatever they are. And then eventually, they revert with material price increases when you go to negotiate because in a sense, the customer needs us as much as we need them. So the current conditions are very strong and people are coming to Smurfit Kappa because we are offering security of supply. Supply chains themselves across the world are changing, and we'll continue to. They were already starting to change pre-pandemic, but we see very significant growth in the Maquiladora region in Northern Mexico because people are onshoring from China because of the container issue. And it's just a question of time until that stream becomes a flood because that's what's going to happen. And so -- and that's why we're investing in new corrugators up there, new investments and development, so that we can take advantage of that. But -- so the macro trends are really in our favor at the moment. And as long as the world stays around, I don't expect that to change.

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

Just two questions for me, please. Firstly, just on box pricing again, sorry. It appears that the lag between recovering higher cost to box pricing has shortened. I just wonder if you could give us some color behind what's driving that at the moment? And is it sustainable? And then secondly, to add to what Lars was discussing, we've seen the China lockbox for laundry pods kind of stands out as one with no further evidence of that conversion from paper to -- from plastics to paper. How is this Smurfit Kappa offering on primary packaging solutions to customers evolved over the last number of years and how prevalent is primary packaging within the business at the moment?

That's a big one. Okay. And on the box pricing, I wouldn't say it's changed that much, David. I mean the -- I suppose with -- why you're seeing some acceleration is probably because we're going to our free market customers quicker to recover these increases, which have happened in quick succession. So that sort of masks probably the normal evolution of box pricing in certain of our contracted customers. So we're going quicker on the free market and recovering more because we're recovering inflationary costs as well with them. So that's probably masking the fact that there's not that much difference with regard to the lag here. I would say that some customers are very understanding, not all, but some customers are understanding that these costs that we've absorbed are huge. And even if we have a contract, some of them are giving us increases in advance of the contracted period obviously, we ask, and sometimes we succeed and sometimes we don't. But -- so I think it's -- there's no real change in that whole area. With regard to primary packaging, I think corrugated has become more primary over the years, as we go on to shelf-ready packaging and the evolution of the sustainability agenda is going to make us even more primary. But I think you only have to look at supermarkets and you'll see how much how many products are sitting in corrugated trays, which is the transport medium to -- on the shelves because it's obviously cheaper for supermarkets to just rip up in the front of the box, which looked good and put the products on the shelf that way rather than decamp them with labor, a, doesn't exist, or b, is too expensive. And so we become primary just by the evolution of labor, I would say. But with regard to the specifics of sustainability, I think that, of course, where plastic -- I mean you can go around any amount of supermarkets and you will see an enormous amount of plastic packaging and to refer to your China lock example. I mean that's obviously an innovation that we have, but we have a number of that in that area. And that -- I would say, a lot of those plastic hubs will change over to corrugated in time. But as I mentioned to Lars, unfortunately, but unfortunately, everybody sold out and getting product to market is the primary objective right now. So we have loads of these projects in the pipeline. It's a question of when they land.

Our next question comes from the line of Cole Hathorn at Jefferies.

Just two questions on my side. One around demand and another one around inventory levels. Firstly, on the demand side, some of your -- the U.S. reporters have called out kind of supply chain issues impacting demand in the U.S. But the commentary we're getting from the European side is demand trends continue to be really strong and people are sold out. So I'd just like to hear your thoughts on the difference between the 2 markets of the U.S. versus Europe. And then similarly, on inventory levels, the U.S. probably normalized their inventory levels in containerboard slightly faster. I mean they ran our mills very hard in the third quarter. Whereas in Europe, the feedback we're getting is inventory levels continue to remain low. And I was just wondering what you're seeing from the inventory standpoint? And any color you can provide there?

Okay, Cole. On the inventory side, demand is still very strong in Europe. And I mean the markets are similar, but are not the same as the U.S. We don't see any significant imports coming from the U.S. to Europe. Obviously, there's a container issue that makes it even more expensive to ship from the U.S. to the world, so to speak, but -- and the availability of containers. So we don't see any imports to any great extent coming in. Our own inventory is low for the reasons we've already said and you've just alluded to, our demand remains very strong, and there's been no real change to that, except around the edges. I would say to the issue you say about supply chain, I mean there's no question that supply chain issues have hurt us, and they cost us many millions during the third quarter across the countries because we are having to ship paper from 1 factory to another. We are having to run grades of paper to meet demand that necessarily we wouldn't necessarily do at a higher cost, we are facing ourselves, some truck driver shortages and our customers have seen the same. So there's no question there are supply chains that are being disrupted, but we ourselves have been able to manage through it. I mean we are seen as a very reliable partner for our transportation companies. And so thus far, we -- I mean you never know what's going to be around the corner. But thus far, we have not experienced too many great difficulties with the supply chain. Some of our customers do and that affects demand from a week to week, are the -- one of our larger -- companies had a problem with getting glass. So we lost some volume. I think it was last month in October because they have to stop the factory. So there are always issues with various different customers that we -- that have their own problems, but it's not affecting us as of yet and didn't affect us in October, other than cost.

And if you could just allow me one follow-up is, I mean, if I just think about your model being integrated and the fact that you've invested in a lot of your mills over time as well as your box plant network. I mean how well-positioned are you versus the smaller containerboard producers in the market? I mean, are we in a situation where players like yourselves that have invested and reduced your cost of your paper mills? It's just going to be so much better positioned versus the top end of the cost curve and that cost curve effectively steepening in containerboard because of energy, because of logistics, et cetera?

I mean I think the integrated model has proved its South coal that, as we've said before, we ride containerboard on the up and we suffer we corrugated and equally when containerboard goes down, we retain in corrugated longer. So our whole raise on, if you want, is that we are an innovative packaging solution provider for our customers, 65,000 customers. And behind that, we continue to improve our mill system beyond recognition to what it was even 5, 6, 7 years ago. And now the Verzuolo mill is just another big addition to the top of the tree, so to speak, in cost advantage. And it doesn't mean that all our mills are the lowest cost per se versus someone who's putting in a 10.5 meter paper machine. But because of integration and because of the way we run our machines and because of the supply chain that we exist within the integration, with the exception of moments where you have very, very strong demand, and you're having to duck and dive in paper mills and run different grades. But we run our mills with a very low cost because of supply chain reductions and performance optimization on the paper machines. And that's what gives us the edge through the cycle. Together with our innovation. I mean, when you've got the pool all of 1,000-plus designers around the world, and we see this whenever we go into by a company. For example, the company we just bought in Peru. I mean it's like Aladdin pay for them to see all the opportunities they have to look at all our designs and help. And then, of course, then it's for them to execute at the right margin with their salespeople to get more business. And that's why we're installing new corrugator there, and that's why we're developing that business quickly because -- we see a lot of opportunity down there with the packaging knowledge that we have. So that is the advantage of Smurfit Kappa is yes, we're very low on the cost curve. Yes, the integration model works. But also we've got bulk of data and skill that no one else can replicate.

Our next comes from the line of Mikael Doepel of UBS.

A couple of questions from my side. Firstly, on the volumes. Now Q4 last year was a fairly strong quarter. I think your volumes were up by about 6% year-over-year. Now given what you see in the market currently, would you expect to beat that quarter and show growth this year as move on?

Yes. Well, I mean, at the moment, we are, I can tell you about October was a stronger month than last year by a decent margin. So obviously, we have to wait until December and November, but our order books are full. We have added capacity during the year. So I would expect to see growth. I don't know what level it will be over the 6%. But I think that if October is anything to go by, there will still be very good growth. But we'll wait and see. December, Mikael is always a funny month -- But this year, I think it's a longer month than normal. So I think we would expect to have a good quarter, notwithstanding the fact that energy is a big cost to us in the quarter, which we will progressively recover. But aside from that, volumes are very solid, very strong at the moment.

Okay. That's very clear. Then in terms of the price increases. Now you called out the 2% sequential box price that you got Q2 compared to Q1, and now you've got another another 7% into Q3. At the same time, we have seen very, very high cost inflation across various inputs and logistics and so on. So I was just wondering, going forward, what kind of a quantum of price increases would you still need to recover the input cost inflation over the next couple of years? Are we stocking double digits from here or something else? Is there any color you could give on that?

Well, because that's such a difficult question, Mikael, I'm going to give that to Ken.

Mikael. I'll give you the ecumenical answer. Just to correct one thing there, the sequential Q2 over Q1 was 5% rather than 2 and the Q3 over Q2 is exactly 7%. I suppose the short answer is, Mikael, we never kind of front-lead on box price increases. It's clearly, as you know, there's a ton of commercial sensitivity around that. And indeed, I think it probably limit our phrase that some of our ambitions if we did that. I'm not sure we're going to do that. I think what we can say is, as we kind of noted earlier, whether it's recovered fiber, general inflation costs or indeed energy in the current market, they're all progressively being recovered as we sort of move through the system. -- against that backdrop of where we sit now with containerboard being kind of up EUR 360 a ton year-on-year, and that kind of naturally feeding through the rest of the system. So we don't have a target. We just aim to do as as good as we possibly can. And as Tony noted earlier, strong demand backdrop, tight inventories, good outlook, so the conditions are fairly well set for us.

Yes. That sounds good. Maybe, just a final question on the containerboard, inventory side, as you mentioned, they seem to be quite tight still in Europe. It could even be below critical levels where we stand today. And as in the previous question, we have seen U.S. normalizing already. When would you -- I understand it's a tough question, but when would you expect the European inventory levels to start to normalize? Is it fair to assume that we're going to go well into next year before that can happen given what you see on the demand side right now? Or how do you think about that?

Yes. I mean if demand continues, there's not a whole lot of new capacity coming onstream in 2022. There's the ramp-up of various capacities that were introduced in 2021. If you remember, Mikael, we were all thinking there would be a lot of new capacity coming in 2021, which would be very difficult to absorb, and that's been fully absorbed by the market and indeed, critically short in certain points of the year, I would say that our acquisition of Verzuolo has allowed us to ensure security of supply for our own box plants next year. I think if you have any sort of normal demands, next year will continue to be tight. And thereafter, sometime in '23, '24, you're going to see some of the new capacity come in, and then it will just depend on how the market is and how it's able to absorb the capacity that comes in. But there's unless you have a dark view of the world of demand, then I would suggest that containerboard is going to remain tight in Europe for the foreseeable future. But that's my current guess. I don't see any reason for changes.

We have one final question in the queue, and that's from the line of Sam Bland at JPMorgan.

I've got three, if I can. The first one was on the sort of freely negotiated prices. You said you're going kind of at those quicker than you would. Is there any real sort of pushback against those price increases? Or do customers basically just realize that everyone else has got the same problem as well. Second question was on whether sort of indexed prices, particularly the 12-month index prices. Are those sort of evenly spread through the year the renegotiation dates? Or are they sort of clustered around a particular month? And then the last question was if volume is very strong. I was wondering whether -- do you think the market is also very strong or maybe you gaining a little bit of share. I was wondering particularly whether some smaller independent box makers might just be struggling to get the paper they need.

Listen, I mean no customer likes price increases, but the quantum of price increases and the amount of times we're going to customers is an unusual time, but it's also unusual across all their product lines that they're purchasing. So I would say the pushback we get is limited other than the fact that they don't like it. But at the end of the day, we don't like the price increases that we've had in energy and waste paper and starch and pallets and everything else that we have. So the reality is there is no option for us then go and push these prices quickly, and get them through quickly, and that's what we're doing. And so pushback, I would say, don't like it, but it's because everyone else is doing it to them, it's easier than it has been in the past. I think that with regard to index, there's some degree of evenly spread there. There will be a lot that will be year-to-year. So we made some, let's say, less than good deals last year that will come off at the start of this next year, and they will the material price increases with certain of those customers. And I'd say it's sort of weighted towards the fourth quarter, as you would expect, as a new pricing coming in first month, second month of the year. With regard to volumes and share, I think it's fair to say that we didn't have a whole lot of paper now that we have paper, we are in a position that we can go and get some more market share, and we've certainly seen many customers coming to Smurfit Kappa because of the security supply issue, which is probably the first time that customers have really realized how important it is to have a solid steady packaging supplier like us, many already have, but many perhaps didn't in the past and now are -- as I said, we were with some customer yesterday, and they're doubling their volume with us because of that particular issue. So I think there is a realization out there that having a reliable packaging supplier is really important in these kinds of inflation and price is not the #1 issue. The #1 issue is security of supply.

Okay. We have had some further questions come for, but I believe we've run out of -- so I'll have back to you for the closing comments.

Okie, dokie. Well, thank you all again for being on the call. We're really excited about the company's prospects, the capital allocation decisions we've made together with the industry's long-term growth drivers have really transformed the quality, scale and reach of the Smurfit Kappa business. As I've said already, we've never been in better shape, and we look forward to 2022 and beyond from a position of strength, and we see -- we're very excited about the opportunities that we see. I would, of course, like to give my thanks to all of the Smurfit Kappa team for delivering the performance that we're doing and for sustaining these prospects going forward. I appreciate all of your attention and appreciate you coming on the call and look forward to seeing you again in person in the not-too-distant future. Thanks again. And look, and if I don't speak to you before Christmas, have a Happy Christmas.

Thank you. This now concludes the conference. Thank you all very much for attending. You may now disconnect your lines.