Sonoco Products Company (SON) Earnings Call Transcript & Summary

Good afternoon, everybody. Welcome back to the 2020 Goldman Sachs Virtual Industrials and Materials Conference. For those of you who don't know me, I'm Brian Maguire. I cover the U.S. paper packaging and environmental services group here at Goldman. We're very pleased to introduce our next company, which is Sonoco products. They're one of the more diversified packaging companies in our coverage. They've got some applications in paper, in plastic, running paper mills, recycling operations. Pretty broad, touches almost every aspect of the paper packaging and even environmental services parts of my coverage. So we're very happy to have them today. Joining us is Rodger Fuller, EVP of Operations; also Julie Albrecht, who's the CFO; and of course, Roger Schrum from Investor Relations. Team, it's great to have you here. Thanks so much for taking the time.

Thanks, Brian.

Before I -- I think Rodger has got some prepared remarks to kick us off with. Before we get to that, I just wanted to remind the audience. You have the ability to ask some questions. Due to the virtual nature, obviously, we can't do it live and in-person, but there should be a dialogue box on the webcast. If you are comfortable, type your questions in there. They'll come into my inbox. And towards the end of the session, there'll be a little bit of a period of time where I'm able to ask that to the team. So please get your questions in early if you have them. And with that, I'll turn it over to Rodger. Rodger?

Thank you, Brian. This is Rodger Fuller. Good afternoon to everyone. Let me start by providing a brief COVID-19 update. I really can't come close to expressing how much we appreciate the great work all of our associates are doing during these unprecedented times. The extraordinary efforts of our people who are executing to meet the critical needs of our customers are truly humbling and inspiring. Our team's effort of controlling what is vitally important, including the health and safety of our people, the quality of our products, productivity improvements and cost management led to an outstanding first quarter. I would also point out that our balanced mix of consumer and industrial platforms performed extremely well during the quarter, as we had strong results across many of our businesses, particularly in the month of March, which we believe was largely a result of consumers spending more time at home. That said, the pandemic impact is clearly starting to weigh on some of our served markets in the second quarter. Also the unprecedented increase in recycled fiber cost will have a significant negative impact on our second quarter results, but we will eventually recover as we have done historically. Because Sonoco is a global company with more than 320 operations in 36 countries, we've been experiencing the realities of virus outbreak since it was first reported in China in January. As the virus spread throughout Asia, into Europe, the Americas and now across the globe, we've been working with our team to protect and help our associates meet the critical needs of our customers and, where we can, contribute to our communities to help drive increased testing and assist health care workers. Throughout the globe, Sonoco is an essential provider of consumer, industrial and medical packaging. 80% of our consumer packaging sales are linked to food products, where we're being called on to meet the increased demand for consumers who are staying close to home. Our paper operations in U.S. and Canada produced over 200,000 tons of uncoated recycled paperboard, which is used to wind toilet paper and other tissue and towel hygiene products. Our global tube and core operations play a key role in servicing the food, hygienic, medical and textile industries. We also produce flexible and thermoform medical packaging, and our ThermoSafe division provides temperature-assured packaging for critically needed virus testing and transportation of life-saving vaccines and other drugs. In addition, I'm extremely proud of our associates who've rallied to our customers' calls for help during this crisis to aid in fighting this deadly virus. In March, our Alloyd division received an urgent call for medical products -- from a medical products customer to see if we could use our unique digital printing and laser scoring capabilities to produce plastic face shields to be used by medical providers and first responders. I'm pleased to say our Alloyd team is filling the order, while expanding our capability to meet much larger orders coming from new customers. Our ThermoSafe division has geared up operations and is working with one of the nation's largest logistics companies and a large medical products company to ship virus test kits to hospitals and medical research labs across the country using our unique temperature-assured coolers. SONOCO TEQ, our medical packaging business, is currently gearing up to produce larger quantities of thermoscan thermometer covers, which are essential for safe use by health care providers. Now let me switch gears and spend just a few minutes talking about our recently announced Project Horizon, which is what we're calling a new $83 million capital investment over the next several years that will significantly lower our uncoated recycled paperboard operating cost in the U.S. and Canada. The majority of this investment will go towards transforming our Hartsville corrugated medium machine into a state-of-the-art URB operation, with annual production capacity of approximately 180,000 tons. This new machine is being designed with the goal of being the largest and the lowest cost producer of URB in the world. We're calling the investment Project Horizon, as we'll be creating a much brighter future for our North American URB system and resolving the volatility we experienced over the past several years as a small independent producer of corrugated medium. Project Horizon will start with the development of a new recycled fiber stock prep system in Hartsville, which will allow us to use lower cost mixed paper and old corrugated containers as our raw material. Design work and stock prep development will begin later this year, and machine conversion should be completed and online in early 2022. As part of the mill system optimization program, we'll also increase capacity of our low-cost Corenso mill in Wisconsin. After the ramp-up of production, we're projecting this investment will provide about approximately $24 million in annual cost savings and deliver returns well above the cost of capital. As a result of the #10 machine conversion, we'll be exiting the volatile corrugated medium market by the end of 2021, and the expected efficiency of the converting machine will give us the opportunity to rationalize some of our higher cost assets in our mill system. In related actions, we made a difficult decision to permanently close our #3 URB machine in Hartsville, South Carolina and our Trent Valley, Ontario, Canadian paper mill due to slowing market conditions. Finally, Project Horizon will also generate important environmental benefits, including reducing electricity consumption in our U.S. and Canada paper system, which will drive a 16% reduction in greenhouse gas emission, while total water used by our mills in the region will decline by 25%. Now as I mentioned earlier, we're starting to see the pandemic impact weighing on certain of our served markets this quarter. We put together a graphic, which is on Slide 16 of the deck we sent out, which attempts to illustrate the impact of the pandemic entering the second quarter on our diverse platforms, with green meaning it's generating a positive impact, in some cases, a very positive impact; yellow meaning neutral; and red, obviously, meaning a negative impact. Specific to our businesses, we expect our consumer-related business to continue performing well in the second quarter, as food consumption trends should continue to be driven by stay-at-home consumers. In addition, we expect our paperboard operations in North America and Europe to be relatively stable, as increased demand for paperboard serving the tissue and towel market to help offset declines from some of our industrial converted products businesses. Unfortunately, tubes, cores and cones volumes are expected to be negatively impacted around the world, although there are pockets of strength in certain markets, such as plastic films. As I mentioned, we have seen an unprecedented increase in OCC prices. Since March, prices have risen $75 a ton to $125 a ton in the Southeast. This will benefit our recycling operations, but provide a significant price/cost headwind for our paper-based businesses during the quarter until we achieve recovery in the second half of the year. As a reminder, most of our paper and tube and core contracts have quarterly material cost recovery mechanisms. In addition, we've announced a $50 a ton price increase for paperboard in a minimum of 8% increase for tubes and cores in North America and similar increases in Europe to further help us recover this higher inflation. We've also announced a price increase for our paperboard cans. Finally, our ThermoSafe temperature packaging business continued to produce strong results, as it's supplying tools critical for virus testing and pharmaceutical transport. However, we expect second quarter earnings in our Protective Solutions segment will be negatively impacted by lower demand in our molded foam and consumer fiber businesses, which serve the automotive and appliance markets. In closing, I wanted to touch briefly on our financial flexibility and liquidity. Recently, we sold $600 million of senior unsecured notes maturing in 2030 with a very attractive interest rate of 3 1/8%. This bond financing, our first in nearly 10 years, increases our liquidity to a level that we believe enable us to more than meet our commitments, even in a prolonged virus-induced downturn, as we continue to ensure the long-term financial health of Sonoco. And this action further enhances our financial flexibility, and we currently hold cash and available credit capacity in excess of $1.2 billion. So with that, Brian, I'll turn it back over to you for questions.

Yes. Thanks so much, Rodger. That's a great recap. And again, for the audience, if anybody has questions, please ask them to the webcast, and we will get to them at the end. But I'm going to transition first to the fireside chat portion, and I got a number of questions of my own. It's been almost a month since you reported earnings. You guys were kind of at the front end of the reporting cycle, and you were able to give some color on trends as we exited March and entered April. But now that we're kind of almost a month in, quite a bit has changed. OCC is up. I think that was already kind of contemplated. But wonder if you could kind of just talk about that headwind versus your assumptions and then just general volume trends over the last month, if there have been any surprises, either positively or negatively versus what you were sort of talking about on the earnings call.

Okay. Brian, thanks. Yes, I think if you could turn on to Slide 16, if you have it, if not, I can talk you through it, it's no problem, I'll start with volume and then we'll come to price/cost. But what we tried to do on this slide, as I said in my prepared remarks, was show the positive impact from the virus on certain markets, and that's primarily our Consumer Products segment, which is 80% focused on food. We guided towards low single-digit growth in our Consumer Products segment for the quarter. And so far, we're seeing more positive volume trends than we expected primarily in our paperboard can or our composite can business, as consumers stay at home more and, of course, add products to their pantry. And it's really across the spectrum, snacks, nuts, biscuits, powdered beverages and the like. We're seeing more positive. And also in the ThermoSafe business, we also see more positive trends than we expected. On the right-hand side, the negative side, we called fairly significant downturns in automotive appliance and in textiles in our industrial business. And frankly, we've seen it more negative than we expected and, in some cases, significantly more negative. So if you balance out what we've seen from a volume standpoint, a little more positive on the left-hand side, a little more negative on the right-hand side, from a volume standpoint, Brian, we feel like we're still right in line with the guidance that we provided for the second quarter. We feel like the guidance -- the midpoint of the guidance is still very accurate. We're a month through, so a lot could change, but that's where we see it right now. On price/cost, you're right. We guided to OCC being over $100 for the second quarter. This last move of $40 up in May takes it to $125, so it's higher than we -- it's somewhat higher than we expected. That's why we moved aggressively before the $40 came out, frankly, and announced the price increases that are implementing, as we speak, over the next week or 2 in both our URB and in our tube and core system. So yes, we will see significant negative price/cost in the quarter from the OCC spike. But as you know, from your history with the company, we're very effective, especially in our paper business, going out into the marketplace and recovering inflation, through our price change mechanisms to the price increases we've announced, as we move into the second half of the year, we're confident that we'll be able to recover the inflation that we're seeing today.

And just to stick on that topic. You obviously had the price increases out there with URB and quite a bit of your volume too is tied to cost. So there is an index component here where you're sort of guaranteed to get it on a portion of it. But on the -- if on the open market portion, how do you feel about the ability to get that in light of the volumes? You mentioned being a little bit weaker in some of the applications, some of them in the consumer-oriented ones, like paper towels and tissue, I'm sure those are doing great. But some of the more industrial ones, maybe a little bit more challenged. Just maybe you can kind of talk about what the market reaction has been and feedback so far is on those pricing efforts?

Yes. So far, Brian, I'd say we're optimistic. I mean early on, as you would expect, some very sensitive conversations about the timing of the increase because of the virus and the impact of the virus on the economy and many people. However, once that second OCC move came out in May, we expected it would go up again. Frankly, we'd expect that much. We knew it was coming. That really solidified our argument that our raw material prices are moving up to the extent that we have to move our paper prices. So at this point, we're feeling fairly optimistic. Same in the tube and core side of the business, with our market position, our service and quality advantage in the marketplace, what I'd say is, so far, we're relatively optimistic with being able to implement that price increase. As you said, about 30% of our industrial business is noncontract, so that's where this price increase is targeted. About another 1/3 or a little more is based off of OCC. And the final 1/3 is based off of the RISI index. So as we move our URB prices up, we're confident that RISI index sometime -- probably my call would be sometime in the third quarter would start to move as well. We have to see. That's an external index, so we don't control that. But again, as we roll into the third and fourth quarter, we're fully confident we can recover the OCC inflation.

And when you say RISI might move up in the third quarter, do you mean that, that's when it would hit your income statement? Or do you mean that you think that's when they'll actually publish the price increase that you guys have nominated out there?

I expect it will take a few months -- my opinion is, it typically would take them a few months to actually publish the price increase. In an environment like we're in today, I'm sure they're going to make sure it's sticking in the marketplace, that it's fully implemented. That's the history that I have. It could happen sooner. It could happen later. But the other moves we're talking about open, noncontract are happening now. Our price change mechanism is based on our raw material. OCC will change in the first of the third quarter.

Okay. Perfect. And as far as the lags on...

Brian, we can't hear you.

We can't hear you, Brian.

Sorry about that. Can you hear me now?

Yes.

Okay. Joys of virtual conferencing. The lags on those, are they still probably about a one-quarter lag until it would hit your income statement, you feel like?

Yes. The -- on the OCC-based pricing mechanisms, that will go into effect the first day of the third quarter. So there are quarterly price change mix, and they change based on the impact of the quarterly OCC moves.

Got it. And I guess just to switch over to some of the more longer-term topics in the industry. Coming into this crisis, sustainability was probably the biggest buzzword in the industry. We heard a lot of momentum behind it. You guys had the Investor Day in December, talked about some new initiatives, some new products that you were rolling out, some new customer wins that were going to ramp through the course of 2020. Hoping you could just update us on those. And to what extent the virus may have changed, either the urgency of customers to try and address the issue or the ability to physically make those sort of packaging changes given the other kind of operational complexity, getting into plants and everything that the virus has kind of brought to us?

Yes. Good question. Sustainability is still very critical to our -- to almost all of our customers, and activities continue. But I would say, and I think Roger Schrum describes it well, it's more of a pause at this point. With the other initiatives around virus and just keeping product on the shelf, we've seen a number of our customers pause those efforts. Now if you look at our major customers with some of the major products, they are out there. They are very popular. You would know them, if I said them. We have ongoing everyday work continuing to make their packaging more sustainable, either through adding recycled content, making the actual package more recyclable through mono-material, getting the appropriate recycling messaging on the container, all those activities have continued through video conferences, through teleconferences. But in general, I'd say, there's been a little bit of pause. That's not going to change, we think, the long-term move towards sustainability. But we have seen somewhat of a slowdown and, probably, in some of more of the new product work and the new package work. What's existing out there today, improvement efforts are ongoing. And what's new products that's probably a little bit slowed down, we see that picking up again later this year or as soon as we start to ease ourselves out of this crisis.

And just thinking about the longer-term ramifications of the virus and how consumer behavior might change. We -- a lot of people have thought about it in terms of maybe eating at home more versus eating at restaurants more. I would guess that's kind of a net positive for you. But also as it impacts sustainability, some people theorized maybe there'll be more of a desire for single-use plastic or single-use anything, and the renewability, recyclability of things, people might look at that as almost potentially a little bit of a negative given the contamination potential that's there. I mean do you think that's a real issue? And do you think that this could just change the whole debate and conversation around single-use plastic and some of the efforts that people had made in the last couple of years just never really picked back up again?

I don't think it will change it totally, Brian. I think it will just. We've been looking at thinking about planning for what are the long-term -- medium- and long-term impacts of what we're going through today with the virus. We should really see 3 major focus areas. One, you already mentioned it, more people eating at home, cooking at home. As you said, that's a net positive for our consumer products group. It helped us short term. We expect it will continue through the rest of the year and into next year. You won't see the pantry stocking, but we will. If more people are cooking and eating at home, that's a net very positive for Sonoco. The second area is more safety and security around your packaging. So not so much, people forget about the environmental impacts or change in discussion around the environmental impacts of resin-based packaging, but maybe focus more on safety and security. Rigid plastics, flexible packaging has a very good story in that area. We feel like that will benefit our resin-based businesses. And the third major area we're thinking about is health and well-being. I think, obviously, coming out of this virus, coming through this virus, people are going to be even more focused on health and well-being. We've seen that as a trend anyway. But now, that touches a little bit of safety and security. As you know, we've started to move into medical packaging and health care. We've got about $350 million worth of health care packaging today. That's a focus area for us to grow, and we see that squarely in the health and well-being trend going forward. So those are the 3 we're thinking about. They are net positive to us. There's some challenges, of course, but more people eating at home, safety and security around packaging and health and well-being. And those, for us, we feel like are a net positive. Sustainability will be there. We just think it'll -- just the discussion not make it go away.

Yes, that makes sense. I'm glad you mentioned health care. That was going to -- I want to transition over to M&A in general as a strategy. You had the most recent acquisition at TEQ. To me, it seems like a platform type of an acquisition, something that gives you a platform to do more deals in that space. And health care has been a great growing area within the packaging space for the last many years, at least in the last decade or so, an area of growth. And so do you truly see that as sort of a platform deal? Do you think you can build a broader business around it? And when you think about the company's balance sheet is in a great shape, cash flow's in a good shape, when you're thinking about reallocating that, is M&A and M&A, in particular, in the health care space a big priority for the company?

Yes. I'll take the first part of that. Maybe Julie, you can talk about priorities for cash. But the short answer is yes. The TEQ acquisition, which is now SONOCO TEQ, about $100 million. So obviously -- I say obviously, we would not go out and just make $100 million acquisition with the expectation. That's all we're going to do. So we do feel like it was the beginning of a medical-focused, health care-focused platform. The transition of the TEQ leadership team, the integration of that business has gone extremely well. They had a few short-term challenges, but some of their products are focused on elective surgeries. They do a lot of work in the -- around surgeries, light covers, handle covers, those types of things. That's short term. But yes, it is a platform for us. I already mentioned, today, we have $350 million in health care. We expect to expand that. And as we focus on acquisitions today, building on that TEQ acquisition is certainly something we would consider, and we're looking to do. Julie, you want to talk about cash?

Yes. I'll just make a few comments about our liquidity position and maybe briefly capital allocation. But as Rodger mentioned in his comments, we focused a lot in March, April on our short-term liquidity position. And net-net, where we are today is we're investing around $650 million of what we consider excess cash at the parent company, and that's in addition to the $100 million to $150 million or so that we typically have on the balance sheet. But most of that typical cash is around the world, really not readily available to the parent company just based on our diverse global footprint. But -- so that cash, plus our full $500 million revolver availability, again, give us all-in just about $1.2 billion of short-term liquidity that Rodger mentioned. So we're very satisfied with that. Nothing -- we're -- nothing to be concerned about from our perspective. From a liquidity perspective, we're really just holding this cash out of an abundance of caution with just the general uncertainty that we obviously are all experiencing today. Really, our capital allocation remains unchanged, very committed to investing in our business, committed to our dividend and definitely have a continuing interest in bolt-on acquisitions in various strategic areas. So all of that combined -- maybe my last comment it'll just be that we remain very committed to our investment-grade credit rating and are kind of very -- again, very satisfied with where we sit today related to all these items.

Should I take it that there's going to be probably a little bit more cautiousness around redeploying cash in the current environment? You talked about having more cash on the balance sheet, preserving some liquidity. So that M&A, while it remains a big part of the longer-term strategy, probably it's prudent to take a pause, kind of assess what the new normal is going to look like out there, maybe reevaluate where multiples get reset before you start to do too much on the M&A front.

Yes. I think that's reasonably accurate. I mean there are some just logistical challenges today in the acquisition and divestiture processes and that -- it's just more challenging to get out to sites or have people visit sites. So that's just really a practical issue. But we remain very active in a variety of conversations about our portfolio, really pluses and minuses. And I think it's just a matter of time before some things start coming together. We're clearly watching multiples, but there are some very interesting opportunities out there for us. And again, we remain very active in quite a few discussions, but all very consistent with what things we've talked about before.

Great. I'm going to transition over to some of the questions that have come in through the webcast. So we have one just around the operating footprint, the mill footprint and some of the changes you've made. You talked about Project Horizon. But even before that, over the last couple of years, you guys have been pretty aggressive with rationalizing some capacity where needed, consolidating some operations were needed. And I think it was a couple of years ago you talked about a vision in 2020, and part of that was some margin improvement from these types of actions. Are we -- do you think vision horizon is towards the latter end of this process that we kind of are getting hopefully to the point where you've got everything, all the puzzle pieces kind of where they need to be and where they need to fit? Or do you think there's still some more work to be done on mill operating -- mill operations, capacity and rightsizing the business?

I think in the U.S. Canada system, which is our largest, this, really, in my opinion, is not the last, but it's really the final phase of this major investment we need to make just to solidify our leadership position in URB. We have one now. Having the #10 machine converted to the lowest-cost URB machine will extend that leadership position. We started that a year ago with the Corenso mill acquisition. That's a low-cost machine. We're going to continue to invest in that. So I think what you'll see in the U.S. Canada system is it, going forward, to be more, let's call it, normal investments going forward. We do continue to look at our European system. We've got a very strong URB mill system in Europe. We're making some incremental investments there. We'll go through the same type of analysis we've had here. How does the capacity of the system fit together? How do you optimize that as well as looking hard at our converting operations? I think the thing we haven't talked a lot about is all of our global converting operation, our industrial business have done a really nice job of getting the footprint aligned, working more shifts in the plants we're in, taking lines out with higher utilizations, at the same time, keeping volume fairly consistent. So Brian, I'm not sure that's a direct answer. But I guess the direct answer is, we'll see -- I don't see any more major investments at this level needed. It's more of an ongoing investment in ongoing efficiencies, productivity and upkeep of the mill system.

And then last one that has come in is just back to kind of capital reallocation. This was more on the organic side, just thinking about CapEx and CapEx plans and budget. And this year, more of a focus on preserving cash. But as we look out to next year and the year after, do you think that we'll stay at sort of similar CapEx levels? Will there be more of the discretionary CapEx be growth focused or productivity focused? I guess that's -- the question is just any kind of thoughts around where CapEx goes from here.

Yes, sure. I think this year aside, where we've got some unique puts and takes going on between, yes, conserving cash, but also investing in this Project Horizon that we were just talking about. But our probably normal CapEx for the size of business we are right now, if you look back over the past several years, it's probably $180 million to $200 million, and roughly evenly split between growth investments and maintenance projects, and that's at a total company level, while if you look across our businesses, that is not always 50-50, right? We are going to be investing maybe more gross CapEx dollars in certain parts of our consumer business and maybe the paper mills tend to be a little more maintenance-oriented from a capital perspective just due to the nature of that equipment and age and such. Next year will be a little different because of this Project Horizon total, call it, $80 million, $85 million. If we're spending $20 million or so this year, that means that $60 million or so is going to be next year. So not having the crystal ball about 2021, I guess, we'd expect CapEx to be up next year as we continue investing fairly normally in our business and then adding in higher CapEx spend for Project Horizon. Then again, in the normal course, I think this $180 million to $200 million is a really kind of nice range for us, barring anything that we don't have visibility to today other than Project Horizon.

Got it. That's clear, that's clear. Okay. Well, we're about out of time. And any questions as well? I wish you guys all the best. Thanks so much for joining us. Hope you guys are staying safe. Thanks, everyone on the line, especially the ones who submitted questions. I hope everybody enjoys the conference and gets a lot out of it. But Rodger, Roger and Julie, thanks again so much for joining us today.

Thank you, Brian.

Thank you.

Thank you.