Smurfit Westrock Plc (SW) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Smurfit Kappa First Quarter Trading Update Conference Call. [Operator Instructions] I must advice you that this conference is being recorded today. I would now like to hand the conference over to your speaker today, CEO, Tony Smurfit. Please go ahead.

Thank you, Kat, and good morning, everybody, and thank you 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. Keeping note, as we're holding our AGM this morning, we would appreciate if you could limit your questions to one per person. And any detailed modeling questions can be dealt with offline with the Investor Relations team. Before commenting on the results, I would like to express my pride and admiration for our people, not only in their dedication in delivering this set of numbers and in dealing with an exceptionally difficult operating environment to ensure our customers are supplied with packaging, but also in the work they've done to support the Ukrainian people through both financial and humanitarian contributions. The effect of the war in Ukraine has had ramifications across the globe in the first quarter. Input costs, which were already rising, rose further. Supply chains already disrupted became more challenging, but Smurfit Kappa, through our people, responded to deal with those challenges. Both revenue and EBITDA were up 33% in the first quarter of 2022, while the EBITDA margin was 17%. Underlying EBITDA was up over 30% in the quarter, with strong demand across our operations. Additional costs absorbed in the quarter were over EUR 300 million. However, price recovery was strong, reflecting the significant investment Smurfit Kappa has made and continues to make to support our customers' growth capturing the opportunity presented by the long-term demand growth drivers of e-commerce and the need for more sustainable packaging solutions. This performance also reflects our scale and geographic diversity. The recent acquisitions we've made and importantly, a greater appreciation by our over 65,000 customers for our unique integrated and resilient operating model, which provides security of supply and delivery of market-leading innovation and sustainable packaging solutions. The confidence our customers have of delivery, no matter the challenge is a key differentiator for us, and we continue to win new business as customers place an even greater value on the security and sustainability of the supply chain requirements. That commitment to our integrated resilient operating model is illustrated in our actions on internal investment and M&A. Our current investment plan is heavily weighted towards the customer-facing part of our business, building out our corrugated operations. Acknowledging the need for paper to feed that growth, we acquired the Verzuolo mill late last year, which is a world-class containerboard mill, which has enhanced our system and built on the scale and guaranteed the supply for our corrugated product to our customers now and into the future. When customers have concerns over the supply chain, they engage with Smurfit Kappa in the knowledge that we will deliver. The use of our smart applications delivered through our global network of 29 experience centers harness the most complex -- complete set of data in our industry to allow our people to focus on solving customers' challenges. It is truly an unrivaled set of applications and expertise which is increasingly valuable in an ever more complex world. Today, consumers are demanding packaging solutions that are renewable, recyclable and biodegradable. That fact is evident in conversations we have with our customers every day. But more and more, there's a focus on the processes involved in the delivery of paper-based solutions. We recently published our 15th sustainable development report, illustrating clearly the benefit of the investment we've made in our operations to support a greener planet. Our ambitious goals and sustainability targets will help build a sustainable future for our communities and support good business practices. To reiterate what I said on recent calls, Smurfit Kappa today is a structurally improved business in every way with a unique culture and an unrivaled and irreplaceable asset base. We are operating in a business with long-term secular growth drivers which gives us, as a company, significant scope for future growth. To meet that growth, we announced our ambition for accelerated growth when we spoke to you at the end of 2020. We had, at that point, booked slots with machinery providers, limiting delays due to supply chain issues, which have since materialized and minimizing the associated cost inflation. As I mentioned above, I am very proud of our teams who have continued to deliver in these challenging times, ensuring security of supply to our customers while also supporting them through the use of our packaging expertise and approach to sustainability. Our first quarter performance has set a strong foundation for 2022. Demand remains good with continued customer focus on moving from plastic to more sustainable packaging materials, while corrugated pricing recovery is happening. Our multiyear capital plan to support customer growth and to continuously improve our system have also established a strong foundation for performance in 2022 and, of course, beyond that. Thank you, operator. And now we are happy to take any questions from anyone on the line.

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

Tony, I'll start off where you've ended, the EUR 514 million is indeed a strong foundation for the year. You talked about progressive pricing and be also aware, of course, hedges rolling over. But my question is really going to be on, how should we think about that EUR 514 million in the context of the balance of the year, with a particular focus on demand trends. You had -- it appears to have been [ 100 ] basis points above market in Q1. Clearly, the market is concerned about macro trends. And you mentioned, of course, sustainable packaging. How should we think about sustainable packaging as an offset to potential cyclical and that pipeline that you have. So if you can put that into context. And ultimately, how we should think about is EUR 514 million representative or what you believe is a good number to annualize?

Yes. I mean, obviously, we're very happy with the number, Lars, but we faced unprecedented costs in the first quarter. We had said last year, if you remember, that we would be progressively recovering pricing through corrugated during the year as contracts rolled off. Clearly, everyone has been surprised by the amount of cost that has happened in the first quarter, which we've been able to mitigate with some hedging as you've said, but on the energy side, but it's not just energy, it's all other items that are going up -- starch, transport, wages, practically every line item of cost is moving upwards. And to mitigate that, we -- the industry and ourselves have announced price increases, which we are recovering those costs through price increases very quickly, frankly, because we need it very quickly. And we have set ourselves up to not be in the same position we were in last year, where nobody expected inflation. So we had more, let's say, longer-term contracts that we have -- contracts that are slightly shorter this time around. So we are pushing pricing quicker than we would have historically. So I think we are moving in a very proactive way that is working well for us as we sit here at the end of April for the last increase. And so when you look at the context of the first quarter, while there might be some second quarter slight, I won't say, downward, that's the wrong word, but let's say some mitigation to cost in the second quarter, we would expect to see that quickly recover in third and fourth quarter.

And I think, Lars, to your kind of longer-term trend point, I think what we've kind of pointed to over the last number of years is the reality is that the demand backdrop and supply chain has been stretched as tight as they are, people haven't really had the space and time to start thinking about those longer-term structural shifts towards paper over plastic. I think we saw demand coming back even a slight bit and that allowed space and time for projects to kick off in a meaningful way. I think you get natural assets through that, too.

You have to remember, Lars, we are spending a lot of money in investing in our business behind the growth. And as I've said before, in practically every market, we see opportunities to either take -- win market share or follow customer growth or follow new opportunities. And it's not just our corrugated business that's doing well, it's all the other areas of our business that are doing well like bag and box, like our cartonboard companies, our flat paper business, our [ NG ] business, they're all really doing exceptionally well and have exceptionally strong order books at the moment. So the only -- to your point about growth, which obviously, the market is worried about. And of course, we don't have a crystal ball as to what's going to happen with regard to the supply chain and what's going to happen with inflation. But I think the only thing that we see that's somewhat different is a lot of our customers are having supply chain problems, and that has -- is causing them to have less demand, which is causing us to have less demand with specific customers. But remember that 70-plus percent of our business is FMCG related. And whether you shop in one store or another, you're still going to be buying food, and that's still going to be good for our growth.

Your next question comes from the line of Allan Smylie from Davy.

Just one question for me. Look, I think there's a notable difference between how your business is navigating a broader market characterized by supply chain disruptions and bottlenecks given the volume growth you've delivered and what we're seeing, for example, in the U.S. market. And I want to appreciate there are specific regional differences. It would be great if you could give more color on the extent to which your integrated model and security supply has resonated with customers? And as a kind of a follow-on to that and follow-on to Lar's question, like do you think that your market share gains as market tightness starts to ease, could act as an offset to potential demand softening, given your security of supply and how that is potentially resonating with people?

Well, on the second point, for sure, what our customers have seen during the last couple of years is -- and we had problems, let's say, 18 months ago, but to deliver Christmas not last year or the year before. But we solved those problems last year with our Verzuolo acquisition. And what our customers have seen is that the most expensive box that you will ever have is the one you don't have when you're supplied -- when your customers are needing the boxes. So clearly, having a reliable supplier like Smurfit Kappa is a big positive for every customer, and that is going to stick around a long, long time, given what we see in all the other areas of problems. And we do have our problems, too. I mean we have very big logistic issues with very big supply issues in many of our different substrates, but we're able to manage through it because we've just been -- we've been fortunate enough to be planning ahead. You take machinery, for example, which I mentioned in the script, there are a few seconds ago. We've ordered these machines, and we've built our -- we started building some of our mega plants 18 months ago to -- and over the last 18 months. And nowadays, the lead times for these types of things is much, much longer. And while we have some delays of, let's say, somewhere between 1 and 6 months depending on the machinery supplier, there's nothing like having to start thinking about placing an order today for a machine, which would take you much longer than it ever would have in the past. So I think we have a big advantage in that scenario. With regard to demand, I think we've performed well because, frankly speaking, we've done well, and we've positioned ourselves well with customers. And so there are many different companies that you'll see that some have done better and you expect -- you referred to the United States. Some have done better and some have done worse. And we'd like to put ourselves in the better category in that scenario. And I think that is standing to us. And the fact that we have invested, whether it's in Mexico or in Sweden or in Spain or whatever country, it gives our customers real security of supply happiness I suppose, and that's really standing to us.

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

Just 2 short ones for me, please. Look, the pricing you've got through is pretty stellar by all accounts. Just trying to think about what is the risk to demand with such pricing coming in [indiscernible] and [ trough ]? And I guess linked to that as well, what impact do you think that could have on the conversion from plastics to paper in a more medium-term view? And then second question, just on Verzuolo, what type of run rate are you at in terms of internalizing the level of paper that they have into the Smurfit Kappa Group?

Well, on the second -- I'll let Ken take the first question. But on the second question, Verzuolo is about 60% integrated now, and we're choosing to keep additional customers around the mill and strategic customers that we want to keep for a period of time. It makes sense from a transportation point of view for those customers that are less than 60 kilometers away or 100 kilometers away. And so we have -- it helps our whole returns out of the mill. That mill was not hedged at all. So you can see the effect of the returns on that mill that are -- hence necessitated the need for the price increase that happened in April. You can see that a mill like that should be making -- should be one of our best mills and frankly, isn't because it's not hedged. And with the new increase that goes in, it will show the power of the mill in the second, third and fourth quarter, unless energy continues to spike upwards in which case, we'll have to look again at what we do. But that mill has -- is working fantastic. It's a fantastic acquisition, and will be one of our best mills in the system going forward. But about 60% is a long way of answering your question.

Dave, on kind of pricing power, and as we look forward in plastic to paper in the round, I suppose there's a few things to say here. It sort of goes back to something Tony just said, which is the most expensive box is the one you never get. And in reality, that's the market that's been there for a while now, given the demand backdrop and our ability to kind of work through that. And remember, it's not just '22 or '21, it goes back to pre-COVID in reality, but I think people really saw the resilience of the model and the strength of it. And our customers really value that model and the strength of it during not only COVID and post-COVID, but where we are now. I think as you kind of move that forward, I think there's a keener sense then of what can happen in times of stress and times of tight supply chains and our position and place within that has clearly been seen to be very, very strong as kind of probably almost understating the position. And then within that, too, the reality is that when people get on and back on to proper kind of ESG path and targeted to 2030 and 2050, clearly, paper-based packaging and the shift away from plastic too could play a big part in that. Rather that's waste reduction or CO2 reduction in terms of the context of the box itself or the production of it or the delivery of it. Clearly, we have a strong part to play in that, too. So I think pricing power will also play a part in that because what's going to be clear between, if you like, '25 and '30 as kind of companies move towards that kind of timeframe is the ability to not only deliver financial benefits but nonfinancial benefits in the context of the products are going to be equally valued, I think, as we look forward. I'm not sure if that gets to the question, Dave.

Your next question comes from the line of Kevin Fogarty from Numis.

Just a quick one on pricing. And obviously, great price recovery during the period. I just wondered if you could share any sort of color on your sort of non-contracted customers just in terms of kind of price negotiations that have gone on there? Are there any sort of pockets where it's a bit more challenging to sort of pass those prices on or any sort of sectors or pockets where it's not been as straightforward as we've contracted or indexed customers?

Well, simple answer is no, Kevin. I mean at the end of the day, there is an absolute need for us to recover our cost. We have been talking to our customers in the fourth quarter and in the early part of the first quarter, this is pre-Ukraine, that there was a new situation that is an inflation situation that we haven't seen in decades. And so we are dealing with that with all customers, contracted and non-contracted customers. And there's not any specific area that I would say that we are meeting any particular challenges. I mean, clearly, at this moment in time, security of supply and ensuring that they have their product is the most important situation for our customers and we're able to give that to them. And that means a heck of a lot. So it's not unreasonable for us to pass our cost through. Remember this, Kevin, we are investing billions in this business to support our customers and make -- obviously, make ourselves more efficient at the same time, but supporting our customers' growth and their development and we need to make sure that when we invest those billions that we get a return on that, and that's what we intend to do, and that's what we are doing. And so clearly, if we have customers that are not giving us an adequate return, we have to reflect that in the negotiations with them. But in the most part, I would say that we have fantastic relationships with all of our customers, and we're working well with them.

And your next question comes from the line of Cole Hathorn from Jefferies.

The first question is just on earnings resilience. I mean you've done very well to get out ahead of the cost inflation pushing through the pricing in the fourth quarter. Is there any quantification you can give on the quarter-to-quarter box pricing you've realized? And then focusing on earnings resilience through the cycle, how do you think about this business? Ultimately, once hopefully cost inflation moderates, how will Smurfit Kappa be positioned? I mean, should we be thinking that your security of supply that you've talked about, you've ultimately taken some share, hopefully growing some volumes, even if it's a challenging market you've still taken share and you hold on to that box pricing longer because everyone will still be worried about cost inflation even when it continues to moderate?

I suppose on the first point, Cole, to kind of keep it simple, if you remember at the end of 2021, we got to about kind of, call it, 19% box price increase. When you take -- if you take the 33% increase in revenue year-on-year and growth would end up being around that kind of 3% mark, a little bit of acquisition, I think the box price sequential quarter 4 to the end of quarter 1 is in the kind of 8% to 10% space broadly.

Yes. And on resilience, Cole, I think we've said this before that when you are engaged with customers who are looking for sustainable packaging and innovation, because of the experience we've developed over decades, but really put through on the last number of years into our experience centers. And when we talk about our applications, and I think you've seen some of those, you can appreciate that customers want to work with companies that I think are really good at what they do. And I don't mean to sound in any way arrogant, but I think we are good at what we do in regard to helping them with their various different needs. Some -- we call it where the customer's pain is. And we try and solve the pain for them, whether it can be sustainability, it can be innovation, it can be designed from the get-go or it can be just being more efficient across their own logistics supply chain or it can be machinery and how they pack quicker. So Smurfit Kappa is a continuing leader in that whole area. So in a sense, we're the go-to guy and you don't throw that away very quickly. So are we going to be resilient? The answer is absolutely yes. I mean, we wouldn't be investing all the money we're investing in our business without actually seeing the opportunities that our customers are giving us and trying to take those opportunities. And there'll be ups and downs. We always say that success is never a straight line, but we've been doing pretty good in fulfilling our customers' expectations and making sure that they need us as much as we need them. And I think that, that will stand the test of time. And I think we prove that over and over and over again, where customers sometimes leave us, we never lose customers. We might lose lines of customers I'm talking about large ones. We might lose lines of customers. But historically, they come back to us very quickly because they can't get the same sort of quality and service and ideas and knowledge from other companies. And that's something that we've built up. I call it irreplaceable because it is irreplaceable. You can't replace that. And as long as we keep our people motivated and we keep our good talent coming into the company, the company will be resilient and strong going forward.

And your next question comes from the line of James Twyman from Prescien. .

Yes. I'm sure it's a bit early, but Russia is a significant exporter of containerboard. And I'm just interested to know what your understanding of their importance in the European market and whether you've seen any impact in the last month for maybe reduced exports.

Thanks, James. Russia, I think it's around 250,000 tonnes of kraftliner that they export to Europe. And clearly, that's not coming in anymore. So that's going to have to be replaced going forward. The whole Russian situation is obviously in the massive state of flux. They themselves would probably plan to send that containerboard to other parts of the world. But of course, that's not easy because a lot of the ports are -- there isn't enough transportation or there's not enough logistics to get to various different ports. So I would say the Russian containerboard will take some downtime because they just don't have the demand and demand in that country has dipped very significantly. So I think there will be some -- it's not really that significant 250,000 tonnes. It's something, but that will be replaced in the European market by either recycled or kraftliner from some of the newer capacities coming on stream. I don't envisage it been massively disruptive.

We have no further questions at this time. I'll now hand back to Tony for closing remarks. Thank you.

Well, thank you very much, operator, and thank you all for being on the call and also very much appreciate you finishing up early. We'll give you much longer at the half year. But as Ken and I know we have to get to the AGM now. We really appreciate you being on the call, and thank you for your continued support for Smurfit Kappa. We are investing in the company to support customers' growth and reduce -- and making sure that our environmental impact is reduced. And we are taking all advantage of the long-term secular growth drivers of e-commerce and sustainable packaging and that gives us in Smurfit Kappa massive complements in the future of the business and our future prospects. So thank you all for being on the call, and good luck with the rest of the day, and we hope you have a good weekend. Thank you, all.

Thank you. That does conclude our conference for today. Thank you all for participating, and you may now disconnect.