Sonoco Products Company (SON) Earnings Call Transcript & Summary

Hi, good afternoon, everyone. This is Debbie Jones, the paper and packaging analyst at Deutsche Bank. This is the Sonoco call. We were happy to have Roger Fuller, EVP of Industrial and Consumer Packaging; and Roger Schrum, VP and Head of Investor Relations. Sonoco is a leading producer of multiple types of consumer packaging. And Rodger and Roger are here today to answer some questions in a fireside chat format. If you do have a question, please submit it to the portal, and I'll be happy to ask it at some point during the session. Before we start, Rodger is just going to make a couple of opening statements, and then we'll go into the Q&A.

Thanks, Debbie. And this Rodger Fuller. Good afternoon, 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 of all of our associates are doing during these unprecedented times. Extraordinary efforts our people are executing to meet the critical needs of our customers are truly inspiring. Our team's efforts are controlling what it's 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 increases in recycled fiber costs will have a significant negative impact on our second quarter results, but we will 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 the 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 service provider of consumer, industrial and medical packaging. 80% of our consumer packaging sales are linked to food companies, where we're being called on to meeting increasing demand for consumers who are staying close to home. Our paper operations in the U.S. and Canada produce over 200,000 tons of uncoated recycled paperboard, which is used to wind toilet paper and other tissue 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 other transportation of life-saving vaccines and other drugs. In addition, I'm extremely proud of our associates have rallied to our customers' calls for help during this crisis to aid in fighting the deadly virus. In March, our Alloyd division received an urgent call 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. Since that time, we produced more than 1.5 million face shields for 2 different medical supply companies and have expanded our capability and are working to fill orders for an additional 5 million units. Our ThermoSafe division has geared up operation, is working with 2 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 the larger quantities of Thermoscan thermometer covers, which are essential for safety use by health care providers. And finally, we've contributed hundreds of safety glasses, face shields and other PPE to area hospitals to provide protection to frontline medical professionals during the pandemic. Now let me switch gears and spend a few minutes talking about our recently announced Project Horizon, which is what we're calling a new $83 million investment over the next several years that will significantly lower our uncoated recycle 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 lowest cost producer of URB in the world. We are calling this investment Project Horizon as we will be creating a much brighter future for our North American URB system while resolving the volatility we experienced the past several years as a small independent provider 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 be in the second half of this year, and the machine conversion should be completed and online in early 2022. As part of the mill system optimization program, we will also increase the capacity of our Corenso mill in Wisconsin. After the ramp-up of production, we're projecting this investment will provide approximately $24 million in annual cost savings and deliver returns well above the cost of capital. As a result of machine conversion, we'll be exiting the volatile corrugated medium market by the end of 2021 and the expected efficiency of the converted mill machine will give the company the opportunity to rationalize some of our higher cost assets in our mill system. And in a related action, we made a difficult decision to permanently close our #3 URB machine in Hartsville, South Carolina and our Trent Valley, Ontario, Canada, paper mill due to slowing market conditions. After this investment, the completed Sonoco's mill system will be in the top quartile of performance and a third-party analysis projects, we'll have nearly a 20% cost advantage over the nearest supplier and this investment will also ensure the long-term viability of our Hartsville, South Carolina paper mill complex. 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 presentation deck we sent out, which attempts to illustrate the impact of the pandemic entering the second quarter on our diverse platforms with green meaning is generating a positive impact and, in some cases, a very positive impact; yellow meaning is neutral; and red, of course, a negative impact. Specific to our businesses, we expect our consumer-related businesses to continue performing well in the second quarter as food consumption trends should continue to be driven by the stay-at-home consumer. We expect our paperboard operations in North America and Europe to experience continued increased demand for lightweight paperboard serving the tissue and towel and composite can markets. However, this will be more than offset by declining demand for heavyweight paperboard used in many of our industrial converted products businesses. Unfortunately, tubes, cores and cone volumes are being negatively impacted around the world, although there are pockets of strength in certain markets such as high-performance plastic film. As I mentioned, we've seen unprecedented increase in OCC prices. Since March, prices had risen $75 a ton to $125 a ton in the southeast until as announced last Friday, June prices have eased to $90 a ton. While this price inflation is benefiting our recycling operations, it is providing a significant price cost headwind to 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 and 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 pricing increase for our paperboard cans. Finally, our ThermoSafe temperature-assured packaging business continued to produce solid results as to supplying coolers critical for virus testing and pharmaceutical transport. However, overall, we expect second quarter earnings in our Protective Solutions segment to be negatively impacted by lower demand in our molded foam and consumer fiber businesses, which serve the automotive and appliance markets. In closing, I want to touch briefly on our financial flexibility and liquidity. In April, we sold $600 million of senior unsecured notes maturing in 2030 with a very attractive interest rate of 3.125%. This bond financing our first in nearly 10 years increases our liquidity to a level that we believe enables us to more than meet our commitment even in a prolonged virus-induced downturn as we continue to ensure the long-term financial health of Sonoco. We're using the net proceeds for general corporate purposes, including repayment of existing short-term debt. This action further enhances our financial flexibility, and we currently hold cash and available credit capacity in excess of USD 1.2 billion. Now with that, Debbie, I'll turn it back over to you for questions.

Great, and thank you for that update. I wanted to start and focus on the industrial paper business and see, you did give some updates there. Could you get a bit more granular on kind of how you saw trends by region and kind of how you progressed through the quarter and what your customers are telling you about kind of their order patterns for the coming months, if possible?

Yes, Debbie, I can. Remember, we're 2/3 of the way through the second quarter. So I'll probably focus mostly on the guidance we gave in the first quarter, which has tended to be pretty close to what we've seen. But we'll start -- let's start with our tube and core operations, global operations, focusing on paper mill markets, film markets, tape and specialty markets and textile markets. And what we said really globally as we headed into the second quarter that we felt like that the biggest negative will be around textile, and we guided to about 30% to 40% volume decline in textile. And frankly, we're seeing the high end of that in both our cone and our tube and core operations. And it's really a global phenomenon, not really just looking at one reason. We guided to some pain in the printing and writing and graphics -- newsprint and graphics paper, printing and writing papers, we said 25% to 30% versus same time last year. And again, we're seeing the high end of that, in some cases. And you've read the same things that we have, even higher than that. We expected containerboard to hold fairly firm. It did early in the quarter. But again, as you read more and more containerboard downtime being announced. Globally, we're seeing that start to soften as well. A positive on our tube and core side has been our film business, as I mentioned in my opening comments. We expected about a 3% year-over-year positive. And a lot of this is stretch film on food-type products, and we're seeing that play out about as expected. So I'd say on tube and core, as expected in the U.S., in general, we said low-teen reduction from a volume standpoint. In Europe, we said probably 7% to 9%. The quarter started stronger in Europe and it started to weaken. So I think that's still accurate. So in general, in tube and core, Debbie, I think the guidance we gave was very close to what we're seeing with some puts and takes. On the URB side, I think, as you know, we produced 200,000 tons, as I said, paperboard for the tissue and tile market, that's been continued to be very strong for us in the second quarter. But as we run through the months of the quarter, we have seen a significant weakening in the balance of our markets where we provide board for the other tube and core providers for hedge board, for protective packaging. So heavyweight boards have been under stress for the last 2 quarters. So we're seeing some downside pressure there. I think that gives you the feeling. Go ahead.

Yes. That's helpful. Obviously, some areas are doing better than others. But I'm curious, you've got a URB pricing announcement in the market right now. Can you talk about what drove that? I know there was some pricing weakness reported earlier in the year and kind of what is supporting this effort going forward?

Yes. What drove it was cost, cost inflation, not only OCC, the run-up in OCC, which we've already talked about, but a number of other costs, some normal inflation we see every year, but frankly, cost involved with running our operations through the COVID-19 crisis, our labor costs and other costs to keep our operations running. So it was driven by inflation. So far, again, $50 on URB, 8% on tube and core, 5% to 6% on our composite can, our paperboard can business. So far, we're optimistic. Really, we just now as a time frame for when we're starting to implement those increases. So even with some of the volume challenges that we talked about so far, we're optimistic on pushing the price increase through. It will take some time. It took some, as you would expect some difficult conversations because of the timing around the virus, which we understood. But it's true inflation and true inflation that we need to recover. And historically, we've been very successful at doing that, and I think we'll do that again as we go forward.

Okay. And then recycling patterns have changed a bit in a COVID-19 environment. Is the quality of the paper, the type of paper you're getting having an impact on your business? Has that been an issue?

Well, on the recycling front, we are seeing some stabilization in terms of the material that we're recovering. We did see some real weakness. As you know, the lack of commercial volumes coming from retail because of the closedowns that were occurring that did diminish the -- some of the quality that we're receiving, even the residential throughput we were receiving was not as good as quality, but I would tell you that things have stabilized and are improving a little bit. So the materials that we're getting are a little bit better. But again, we're still probably in that 20% below where we were just a year ago in terms of recovery rates. So we're still clawing back a little bit, but I expect as the reopenings continue to occur, that this will start improving. But we had some pretty sharp declines in the first quarter that really impacting us and the quality was also poor.

The only thing I'd add, Debbie, because we collect our own OCC. We're able to cut off exports or slow down exports when needed to continue to keep some of that higher quality material in our system. So the general trends of what Roger said, impacting our operations, there's really very little or no impact to our paper mills.

Okay. Just sticking with your business here, the segment. You have announced the Project Horizon. What really was the tipping point for you to make that decision to do the conversion? Obviously, this is something that you've been considering a lot of different options for a long period of time. What was it that made this be the final conclusion for you?

Yes. I think the tipping point really was just the continued volatility of the corrugated medium market and the impact. We are, by far, global leader in URB, uncoated recycled paperboard. In corrugated medium, we're less than 1.5% in the U.S. market. So just a small independent provider. And some long-standing relationships we have providing to independent companies were no longer independent through the consolidation in that marketplace. So that's number one. Number two, I think you remember, Debbie, 3 or 4 years ago, we started a plan to invest across our North American mill system and we started with $64 million to invest in our low-cost, high-speed machines to increase the capacity and at the same time, take out high cost capacity across our system. That's been very successful. We've seen the impact of that in our productivity, in our returns, in our industrial business. So really, for me, the movement on the machine here in Hartsville to convert it from corrugated medium to URB is just a continuation of what we started 3 or 4 years ago to have the lowest cost URB machines in the world and then in turn, take out higher capacity in the system because our goal is not to have more capacities, to have the same capacity for less -- at a much less cost driving productivity.

Okay. That's helpful. I'm going to shift over to the consumer business. I wanted to see if we could get a little more granular on some of the volume trends that you've seen over the last few months, I'd like to kind of distinguish between flexible and rigid, if that's okay? And anything notable or interesting that you've seen in this COVID environment?

Yes. On the rigid side, the most positive impact from COVID has been on our Rigid Consumer Products business. And that's in both our paperboard cans, which package, as you know, anything from refrigerated dough to powdered beverages, the snacks and chips, packed chips, all have been very strong globally. So that's been very positively impacted. On the rigid plastic side, we're the leader in frozen plastic trays for meals, for frozen meals, that business has been very positively impacted. So we've seen nice pickup there. Our customers produce things like macaroni and cheese. So a lot of demand, as you would expect, for shelf-stable products like that. So we've seen a tremendous pickup in our rigid consumer packaging operations. On the flexible side, there's been some puts and takes. As you would imagine, with convenience stores until now, mostly shut. Confectionary was pressured in the quarter -- in the first part of the quarter. We're seeing that start to come back now. So that was really on the downside, the negative impact, but also in our flexible business, we make -- we also provide, of course, cookie, snacks, and other products, packaging for those products, which have been positively impacted by pantry loading. So from a consumer side, net-net has been very positive. We've got a smaller business, a nice business, but a smaller business and portion control cups for the food service industry, again, those change -- shut for some time that was pressured early in the quarter, but it's coming back very strong in the last half of the quarter.

Okay. And I hear a lot about customers kind of downsizing SKUs. I'm curious what type of impact if you're seeing that? What type of impact is that having on your business? Does it is just a matter of shifting production, and there's really no margin impact or volume impact. If you could just talk about that a bit.

Short term, Debbie has been very helpful. In the case -- and our customers are downsizing SKUs, they're doing that. So that we can work together to minimize changeovers in their operations and our operations to get more product out the door. So what we've seen short-term is they're relying on their larger SKUs, they're more popular SKUs to get more product out the door. So short-term for us has been positive. I can't really think of a case right now where margins, that drives productivity. So it helps our internal productivity, helps our customers' productivity, but really no impact that I can see on the actual margin of the sale of the package.

Okay. And I'm curious, in your conversations with your customers, do you feel like they're all just kind of -- I'm assuming, just trying to get through this time period until we see the economy opening up a bit. But a decent part of plastic packaging a lot of times is helping with new product development and new innovation. How is that discussion going? How is the new product pipeline? Are people still moving forward? Or are they on pause?

I'd say the major multinational companies are still moving forward, Debbie. I mean we've got a number of -- and most of them are sustainability focused type projects, but we've got a number of very significant projects we're working with those multinational companies, our largest customers. We're doing it through video conferences, we're doing it through, of course, teleconferences, regular meetings. Everyone's becoming much more effective at working that way. It doesn't totally replace the plant visits and the face-to-face, but it's been effective with those companies. Certainly with some of our smaller company customers, we've had impact there. And I'd say it's more of a -- maybe more of a slowing than a stop of projects. But we had a number of pretty significant new product introductions happening as we moved into this challenge with COVID-19. And they're still coming through, they're coming through a slower -- from a slower -- at a slower impact. But again, for multinationals, we've managed. I think our team and our customers' teams have done just a fantastic job of keeping these projects moving. And again, many of those are sustainability focused-type projects.

That's a good segue into the sustainability discussion. Obviously, in my opinion, the plastic packaging industry does play a role in sustainability especially around things like food waste. But I think there is an opinion that the recycling rate really needs to improve significantly around plastic packaging. And I'm curious what your thoughts are on who's responsible for driving that if we look at the consumer, the consumer company, the packager, the chemical producer, the government, if you could just kind of give us your thoughts on how that might evolve over time?

Yes. And before I get into that, I think it's also fair to say that all of those stakeholders that are involved in the supply chain for plastic packaging probably could have done a better job over the past several years, talking about the true value that comes from plastic packaging. And then I think that being on the defensive that was led to a lot of the negative discussion that we had. And if there's one positive thing that's come out of the COVID environment, it's that plastic packaging has really demonstrated really the secure, safe, and sustainable impact that it does have for consumers. So I think that's been a positive. But getting back to your question with regards to improving recycling rates and working more in conjunction with regards to this. Obviously, as a recycler, Sonoco is very much engaged in this practice. And so not only are we a paper recycler, but we do recycling of plastic materials as well. In this environment, there's been a lot of discussion of getting more capital into the recycling industry so that it can improve the recycling rates particularly for plastic packaging. There's a lot of discussions that's going on with various associations to talk through maybe some scenarios that would work. There's a lot of different ideas. I think they're going to result in some consensus that will lead to more input of capital into infrastructure. Obviously, if the recycling industry can't make a return on investment, it's very difficult for them to put a lot of capital into increased recycling rates for plastic-based packaging, same with chemical companies and resin suppliers. There's got to be an avenue that can increase the infrastructure. And so I think there's a lot of positive discussions that are going on with stakeholders right now to come up with a solution that would increase capital going into recovery -- recovering more plastics from the stream, working on better technologies to allow this to occur. I think it's going to be a shared approach. It never helps to have just one particular stakeholder have to pay all the bills. It better if there's a shared approach to this. And I think that, that's what we're trying to come up with is a shared approach that would work.

So if you come back to my conference in 3 to 5 years, do you think that the recycling rate will have improved very significantly. Is that kind of the time frame or is there a more a longer-term effort.

No, I believe it's continuing to increase on its own. I continue to emphasize that infrastructure improvements have to occur, and it's difficult to rely upon one single stakeholder, whether it's recyclers, whether it's packaging companies, whether it's resin suppliers, whether it's chemical companies to put those dollars into make sure that we have improved recycling rates or chemical recovery or whatever the different things are. So I think that a better shared approach would be more applicable. And I think there are some discussions. Instead of having individual municipalities all come up with their own scenario that working through associations and other stakeholders that we can come up with a cohesive plan that will put more infrastructure in place to continue improving the recycling rates as we go forward.

Okay. Thank you. So I just wanted to make sure we touched on capital allocation priorities. Obviously, you're committed to the investment-grade rating. Can you talk about kind of the M&A environment right now? How do you think about that in the COVID market and just kind of if you could touch on what business lines or regions may be attractive here over the next couple of years?

Yes. As you expect, anything acquisition or divestiture related, has slowed some, but there is activity. And as you said, because of the strength of our balance sheet, we're still very much involved in that activity, understanding that it's difficult, and we're working through how you would go through the integration process under the current COVID environment. But it's possible and is working, I'd just say it slowed the activity to some degree. We've said, Debbie, our focus is on -- from an acquisition standpoint, building our growth-based businesses and consumer packaging, our flexible business and our paperboard business, our thermoform plastics business, have continued to be areas of focus for us. We've developed now a $350 million healthcare/medical focused business with our acquisition of TEQ early this year, we would build -- we continue -- we'll continue to build on that capability going forward. We think the COVID -- the result of the COVID-19 issues will be a very positive push in the future for medical and health care type packaging. So we're working through that as well. And then we'll continue to make a tack on acquisitions through our leadership businesses, primarily paper-based rigid paper and cans, tubes and cores and our URB system. So we're always involved. We're out -- there is activity, but certainly, it has slowed with the current environment around COVID-19.

And the only other thing, Debbie, that I would add is that, clearly, our capital allocation strategies are focused on funding business that give good returns on investments. So certainly, the Project Horizon project which will increase capital spending. In fact, this year, we're projecting something in the range of $15 million to $20 million increase of capital spending. Even though we're actually bringing down overall cap spending for the year down about $40 million. So we'll still spend about $170 million this year, and that's down from what we had previously thought going into the year. Second in line, of course, is the dividend, and that's roughly about $172 million a year that we returned cash to our shareholders in quarterly dividends. That continued to be a priority and of course, then that leads into our free cash flow usage and Rodger articulated kind of what our M&A strategy is associated with that.

Okay. Thank you. I was going to see if there's any more questions, and I don't see anything in the queue. So last question I wanted to ask you is, obviously, there's been a leadership change at Sonoco in February, and I wanted to see if you could give us a sense of maybe how things are the same or different with Howard in the current position. I think that obviously he's been at the company for a long time, but this is a new ship for the company. So I want to see if there's any update there.

Yes, Debbie. Howard and I have worked -- I've been with the company for a long time as well. Howard and I have worked together for almost 35 years. I'm in a new position as well, so assuming global leadership for all of Sonoco operations as well as our purchasing and logistics team. And I would say, Howard and I are very well aligned on strategy going forward. I don't know that you'll see a lot different. We talked about the focus areas for growth of the company. I think the one thing that -- and Roger just mentioned it, and the Project Horizon is a good example of it. I do think you'll see more of a focus on some of these self-help type projects. We're investing into, again, some of the businesses where we have global leadership positions to extend that global leadership and take advantage of some of the current capabilities and assets and facilities that we have. So I'd say we're probably going to be more aggressive than looking internally for opportunities to invest, while at the same time, not take -- still take advantage of outside acquisition opportunities. So other than that, again, Howard stepped in, he has done a great job of leading us through these very difficult times. Think about his timing, coming in and taking over the company, and we jump into the COVID-19 issues. He stepped in and provided strong leadership for the company. But as far as what's different, I think that one point about probably being more aggressive and more focused on some of these self-help type activities going forward would be my current takeaway. I don't know, Roger, do you have anything to add?

No. Again, Howard, he's fifth generation of the founder of the company. So he understands the company well, knows the culture very well. And I think that's been embraced by our associates that understanding the culture, living the culture and being able to articulate the culture is always an extremely important part and again, the focus on internally to deal with some of the issues that maybe we've been talking about for a number of years and addressing them in a proactive fashion, such as Project Horizon. That's not a new issue, Debbie. You know we've been talking about the corrugated medium machine for years. So it's certainly something that needed to be addressed, and it's one of the first things that Howard wanted to get focused on and we're moving forward with that project.

Thank you. That's actually a very good color. So thank you for that. And please say hello to Howard for me. And thank you both for participating today in the conference, and hope to see you again next year live.

Thank you. Debbie.

Thank you very much, Debbie.

Thank you. Bye.