Sonoco Products Company (SON) Earnings Call Transcript & Summary

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Good afternoon. Gabe Hajde here, Wells Fargo containers and packaging analyst. You're dialed into a virtual call and fireside chat with both Howard Coker, President and CEO of Sonoco Products; as well as Roger Schrum, Vice President, Investor Relations and Corporate Affairs. I will start today with a few high-level comments from Howard and then go into Q&A. Gentlemen, thank you for participating at this year's event, particularly, once again, given the fact that it's in a virtual format. With that, we can pass it on to you, Howard.

All right. Well, thanks, Gabe. I really appreciate you giving us opportunity. Let me make a few comments, and then we'll -- as you know, we'll take some questions. We're not going to be presenting on the things called today, but we do have a slide deck that's available to you. If you go to sonoco.com, our website, you'll find it there. So let me just add some quick comments. For those of you who may not be familiar with Sonoco, we're the global leader in paper food cans as well as provider of flexible and rigid plastic food packaging. We're also the global leader in the production of uncoated recycled paperboard, or URB, along with tubes, cones and cores used in industrial packaging applications serving the paper, film, textile, tape and specialty markets. These 2 centers of excellence, our consumer business, paper business as well as our industrial businesses are augmented by growing businesses in health care, protective and retail packaging. I'm also pleased that we continue to be selected as one of Fortune's most admired companies and were named for the third year in a row to Barron's Top 100 Most Sustainable Companies. These recognitions are a tribute to our 20,000 associates working in more than 320 locations in 34 countries around the world. Despite the pandemic, winter weather disruptions and supply chain problems, we did produce solid financial results in the first quarter, hitting the high end of our expectations. Our operations were impacted by Winter Storm Uri in February, with more than 40 of our U.S. plants being temporarily shut down due to a lack of natural gas or electricity. Most of the shutdowns were only for a few days, and we were able to meet the needs of our customers. However, the storm aggravated already tight supply chains, which is further impacting the availability and prices for resins, chemicals, adhesives, freight and others. Even with these headwinds, our Consumer Packaging segment had a strong quarter, producing its second best operating profit ever, as many of our products continue to benefit from consumers at-home eating habits. As an example, our global Rigid Paper Container business registered an 8% improvement in volume mix, with North America up 6%, Europe was up 9% and Asia was up a substantial 30% in the quarter. Our customers are telling us that they're seeing young consumers rediscovering staple food, so they experiment with cooking at home. And for example, we've seen a resurgence of products such as refrigerated dough, think of Pillsbury-type products, which was up 27% this quarter in North America and equally as strong in Europe. Our customers are also telling us that the adoption of remote work is providing a structural change in demand for convenient, frozen and prepared meals. This trend is helping our recyclable plastic food tray business, which has seen double-digit growth for the past several quarters. And I believe we'll start seeing some COVID-impacted categories start to improve as markets continue to reopen. Categories such as confection, food service and some health care products are showing signs of growth, and we expect them to continue to improve as the year goes on. We're clearly seeing global industrial markets reopen from the 2020 pandemic recession, which helped our industrial paper packaging segment report sequential improvements and results from third consecutive quarter, although operating profit remains down year-over-year. In the first quarter, industrial segment sales grew 12.5% due primarily to volume growth and higher selling prices implemented to offset the higher raw material cost and nonmaterial inflation. Global tube, core and cone volume mix improved 3% as North American volumes were down just about 1%, which is more than offset by strong improvements in Europe, Brazil and Asia. Unfortunately, our industrial business has continued to be negatively impacted by a negative price-cost relationship due to rising recovered paper, chemicals, adhesives and freight costs. We've mobilized our inflation recovery plans with targeted pricing actions already in the market. Others communicated to our customers and some yet to come. Year-over-year rate of the tan bending chip index has moved up 11% to $780 per ton, and medium prices have moved nearly 20% to $735 a ton. Demand for our paper URB and medium remained strong, and backlogs in North America are at the highest level we've seen in recent history. As a result, we fully believe additional increases that have been announced will be reflected later in the second quarter. After a slow start due to the pandemic, we are making solid progress on Project Horizon and still expect the conversion of our #10 medium machine converting it to URB to be completed in the second quarter of this coming year 2022. As we previously mentioned, we're investing $300 million in capital this year into our Consumer and Industrial businesses. In addition to Project Horizon, we've identified a number of really good projects that we expect to provide solid growth and margin improvements, with returns well above the cost of our capital. Some examples, we're expanding our proprietary Sonoco's appliance packaging technology, which is a replacement for foam into Europe, with the opening of a new manufacturing facility in Poland. The new facility will open in the summer to service new customers, with our 100% recycled paper-based protective packaging. I'll mention, we saw an increase of 29% in Sonoco's appliance volumes in North America in the first quarter alone, and we're looking at several additional expansion opportunities to include Mexico and Turkey. We're funding a number of automation and technology projects to boost productivity in our operations. Earlier this year, we announced we'd be partnering with ISI, which is an advanced manufacturing automation and robotics company, who can help us move forward our use of automation throughout our global operations. In addition, we're funding capital projects across multiple businesses that will speed production, lower operating costs and reduce the need for product handling labor, which has proven to be extremely difficult to recruit and retain in the current work environment. After spending on capital, returning cash to our shareholders remains a top priority. For 96 consecutive years, we paid cash dividends to shareholders, and we've increased our dividends for 38 straight years, and our payout provides just under a 3% yield, nearly twice the S&P 500 payout rate. In addition, our Board has approved a new share repurchase authorization of up to $350 million. This new authorization further demonstrates our financial strength and illustrates our focus on a balanced capital allocation strategy. Finally, we will continue to improve our portfolio by selectively acquiring and divesting businesses to strengthen our core consumer and industrial base. Our strong balance sheet, robust cash flow provides us the flexibility to evaluate and pursue most internal and external opportunities. However, we remain committed to maintaining our investment-grade credit rating. Let me wrap up with a few remarks regarding our second quarter and full year outlook. While we're cautious near term about inflationary risks, we're becoming more confident in our ability to benefit from the developing post-pandemic economic recovery, particularly in the second half of the year. As I mentioned, we expect to see continued inflation in recycled fiber, resins, chemical, adhesives, freight and other operational costs. We have a number of operational and commercial levers that we can pull to offset this pressure, and, of course, that includes pricing. We also expect demand in most of our Consumer and Industrial businesses to remain solid for the foreseeable future. With 80% of our Consumer Packaging portfolio focused on packaging, fresh, frozen and processed foods, we believe we are uniquely positioned to continue benefiting from summer at-home eating needs. Demand for uncoated recycled paperboard remains strong globally, and our tube, core and cone products are also seeing resurgence in demand to near pre-COVID-19 levels in most of our served markets. Finally, I'd be remiss if I didn't mention our sustainability efforts. Recently, we hired a senior leader of sustainability reporting directly to me to work more closely with our customers to identify opportunities to meet their changing product requirements. With that in mind, we continue to expand our EnviroSense line of more sustainable packaging and incorporates increased recycled content and improves recyclability. EnviroSense is represented across our portfolio from rigid plastics to flexibles, our iconic paper containers. In fact, we recently began working with a customer in Europe to transition their product into one of our environment can paper containers from a less sustainable substrate. We expect this trend to continue. So with that, Gabe, I'll be happy to take any questions that you or others may have.

Thank you for that overview there, Howard. I guess, we'll start with kind of the -- I'll say the obvious, but just as it relates to inflation and pricing and kind of what we're hearing, at least that we'll share from supply chain discussions, is that a lot of the CPGs are a little bit more focused on avoiding stock-outs and kind of maintaining share of stomach that they gained over the pandemic versus pushing too hard back on prices. So I'm curious and, again, I guess, appreciating last year was a little largely deflationary, kind of how are the conversations going? I mean, no one invites a price increase, but just in terms of kind of noncontract business to the extent you can comment.

First, noncontract contract, our position within most of our markets is our value proposition is well respected on a noncontract base. No issue. And contracts, we obviously have the mechanisms to recover. What I would say to really add to your point, the discussions have gone beyond what does the contract say, but in order to acquire raw materials, we need to supply. We have to -- we're burdened with extra cost. Those are the type of dialogues outside of contract that we're having, and the reception has been very favorable. It's exactly what you said. We want to keep our customers' supply, they want to keep their customers' supply, but if we have to pay a premium to get the raw materials we need, there has been -- it really demonstrates the level of partnerships that we have that our customers are saying, "Yes, we get it. We understand it. That's not in the contract, but we're going to help you with this." So it's been positive. The question is just catching up. It is almost every day that we're seeing a new level that we have to chase.

Okay. And then I guess, this Monday, you guys even announced a 9.5% price increase for rigid paper containers. I'm assuming that's composite cans. And maybe correct me if I'm wrong, but I was under the impression that product line was largely more contractual or formulaic in nature. So I was just curious if you can kind of describe the nature of that announcement and when that could start to help out the income statement, I guess.

Yes. Predominantly, I would say probably circa 70% of our volume is contractual, so that would be for the non-track customers, and I can't remember, Roger, it was probably a 30-day notice. Mid-quarter, we'll start seeing that play through. As -- and yes -- and most of our contract customers are quarterly or biannual. And again, as I said earlier, some of this, call it, hyperinflation, surcharges, et cetera, those contracts are continuing or those discussions are even continuing with the contract cost, not just with the cans side of the business.

Overall.

Yes, overall.

All right. Outside of COVID, obviously, 2021 has presented a lot of challenges, raw material availability, logistics, Winter Storm Uri, et cetera. I was curious, I think the team, as you pointed out at the beginning of the discussion, responded really well, and you guys delivered numbers kind of towards the top end of your range. Notwithstanding, again, I appreciate that's out of your control, but what issues do you think can correct a little bit sooner versus later? And then more specifically, logistics, it seems like there's a lot of different impacts there, whether it's truck, rail, ocean freight. When that could normalize or what you're hearing from at least your suppliers on that end?

Well, we're heading down the path, let's put it this way. To kind of put it in context, when -- you mentioned the Winter Storm Uri, a lot of us talked about that in terms of downtime days, that pain continues. Some of the downstream chemical providers are just now getting up and running, but they are getting up and running. So we've gone from having daily type meetings about where we're going to source raw materials literally around the world, I mean flying adhesives from Europe and Asia to the U.S. to be able to maintain our operations. Sat on a meeting just yesterday morning, which turned out to be the last meeting, okay? Things are starting to ramp-up. We're starting to normalize. Inflation is certainly a part of that discussion, but that too appears to be starting to level out. So I couldn't tell you specifically. Our forecast say that -- and in our forecast, we're saying, hey, by the end of the first quarter, things should start to stabilize. We'd catch up price cost neutrality from that point. What keep -- what would keep me up at night on that is, do we have another heavy hurricane season in the Gulf Coast and what does that mean, particularly. And you think of that in terms of resins, what really was educational with Uri was the feedstocks that not necessary -- necessarily show up in a polymer to make a resin package -- resin-based package. So if you go on our paper side of the business, adhesives, we need certain select copolymers to be able to produce adhesives to glue paper together, whether you're making a tube, a can or even in the folded carton business. So sorry if I may have rambled a little bit and gotten off course. I don't know if that addresses exactly what you're looking at. I'd say the one thing that I see sustainable through all this is labor availability. We, as a U.S. industry, have been struggling with that collectively, but there's a lot of easy money out there right now. So lower-skilled positions, we're having a lot of trouble just getting the bodies to run the plant. So to address that, obviously, there's a wage discussion there, but automation is becoming more and more important. It used to be a what's the return on investment based on how much labor you save. Now it's how much labor do you save and how much money do you save trying to find someone to fill that job.

Right. We'll, and then turnover and retention of those employees is important too, and part of that calculation, I think.

Exactly, exactly.

All right. One last one, I guess, on cost. We didn't talk a whole lot about recovered fiber. I think information comes out sometime this afternoon. But at least our view and what we read is the near-term expectation is for things to rise even a little bit from where they are today at relatively elevated levels, but that things may be easing in the back half of the year. So outside of what seems to be containerboard markets that are running pretty hard, are there other factors that we should be monitoring, whether it's collection rates or stocking in Southeast Asia outside of China, obviously, that you pointed to, that would give us some kind of direction there?

Yes. Normally, some of the things you named would be things that we would -- we certainly monitor. You mentioned China. Interestingly enough, the Asia, the export pricing has actually started to decline in the last -- from what we've been seeing over the last week or so, which is -- gives you more pause to think, hey, are we going to see the type increases maybe we're thinking are going to see. But at the same time, we're still seeing, within the domestic market, some folks out there with premiums indicating that they're having trouble getting materials. The collection rates, Roger, I'd say, are relative -- they're normalizing out right now post-COVID, so it will be an interesting to see what is announced today. Our expectation is similar to yours that we wouldn't be surprised to see a notch up. We did build that into our guidance more towards the latter part of the quarter, but we also didn't build in some of the price movements that have come in later to help us balance that out if it does pop up quicker than we anticipated.

Okay. On the demand side, and I'll say it's seemingly a theme that I picked up across not just my names, but in talking to some of the other analysts that are presenting today, I think even your closest competitor in their presentation indicated some of their tube or core volumes are tracking a little bit ahead of expectations. So you just talked about tight inventory levels, extended backlogs and running pretty hard to keep up with demand. So number one, I guess, confirm that backdrop for us and then visibility into what's driving some of that demand. I mean, I appreciate, if you think of textiles as an industry that was offline for an extended period of time, and so to the extent that they destocked, they'll have to restock as well as service their customers. But just trying to understand kind of what's going on in the supply chain right now.

Yes. I would, yes, definitely confirm that we have backlogs globally starting with the URB location. So -- and backlog that we haven't seen in years. So the market is very tight right now. The --what markets on from an end-use perspective that are driving that, if I look here at North America, we actually -- in the first quarter, we actually -- we noted that we were down 1%, but you have to look behind the numbers. That 1% was driven by -- we're the largest supplier into the newsprint, fine writing and paper sector. We've reduced our position there substantially from, say, a decade ago. But you know what's happening in that sector. So what does that tell you? It tells you the textiles, film, the containerboard market are all going and going strong. Its -- is it just pure catch-up because of low inventories coming out of COVID? It doesn't feel that way. We're all seeing -- we're the tip of the spear, if you will, but you go out and you want to buy a new washing machine right now, you could be waiting months and months and months. And this is going to go on for some period of time is I'm feeling at this point. It's going to take a while before in a position that inventories get back and start to normalize.

Okay. And then I'm thinking about on the tube and core side as well. Can you remind us again what your exposure is to construction and what you're seeing there? I mean, I think maybe an expectation of delayed household formations, low interest rate environment could spell a nice construction end market for some time.

Yes. We're -- our position -- it's probably one of the smaller segments within our tube and core. If you think of the Sonotube and other formats or variants of the Sonotube, extremely strong. Same story, different day. Probably more relevant would be if you look on the consumer side of the business and our adhesives and sealants. So Sonoco, if you go into your Lowe's or Home Depot, and you'll go to the adhesives, the liquid nails type products and it's a paper version, that is us. We make a 100%, call it, 95% of all paper caulking cartridges in North America and about 50% of all of the plastic ones you see. We're actually approved capital just Monday for additional capacity to be brought in place on the plastic side of the business. Our customers are telling us that while they're as busy as they can be, they see this going on. They're investing capital from a filling perspective, and we're following them. So construction market is extremely strong. And obviously, we're benefiting from that more so on the consumer side, but I don't think the auto folks, Gabe, maybe if you didn't recognize that, that our position in the harbor store is less about the Sonotube and more about how you fill gaps and voids around your house, keep people from running over your cable and that kind of stuff.

Understood. All right. And then I guess, you guys have a more global footprint, again, than maybe some of your competitors. And again, I'm sticking with tube and core and the URB industrial markets. We saw China come out of the pandemic a little bit sooner, and then we were to follow. And obviously, I think we're doing pretty well in terms of vaccine dissemination. But Europe, it still seems like is, I don't know, 3, 4 months behind us. So I'm curious why you said volumes are a little bit better over there. I know there's some puts and takes with mix here in the U.S., but just what you're hearing in other parts of the world?

Yes. Same story. Brazil is the one that I've just been amazed with. We've made more money in our Brazilian tube and core integrated business in the first quarter than we may in a normal year. I want to say their volumes have been up in 40-ish percent, and that wasn't just a hiccup for a quarter. It's been like that for the last 3 or 4 or 5 -- 3 or 4 quarters. Europe is picking up. Yes, I'd say they're at pace of what we're seeing now in the U.S. Asia, similarly, our biggest presence in Asia is in the cone side of the business through our acquisition of Conitex for the textile, for yarn and thread, and they're about 95%. First quarter, they were -- their volumes globally, cone volume was about 95% of 2019 -- or -- yes, 2019. So things are starting to appear to be pulling back up really across geographies.

Okay. Switching gears to consumer. You guys made some investments. And again, the composite can over in Europe, I think you talked about being pretty well fully utilized there and making additional investments or at least evaluating them. Just curious if this is, again, more on the snacking side. How sustainable that might look? And then kind of what you're seeing here in the U.S.? I know you called out refrigerated dough. But I guess, one of the heated debates right now in the investment community is how quickly consumers will go back to their old ways. And even if they do perhaps eating out a little bit more often, they'll swing by and grab it and bring it home, which, I guess, by extension, might still benefit the grocery channel and packaged food. So just more specifically, again, on your composite can.

Sure. We're -- and we're seeing a combination of things. First, let's just talk about the changing trends that's sustaining itself at this point in time, part of which you got to think about is this is not going to be a lights back on, back to normal, everybody is back in the office. There's going to be work from home. It's a phenomenon that's going to continue and that keeps people, obviously, in their homes possibly eating 3 meals a day, at least 1 or 2 at home or maybe they weren't having any before. So I think that's what our customers are saying. Look, this -- they're telling us they think that there's going to be -- maybe not to the peaks that we've enjoyed the last couple of quarters, but it's going to be a step-up from before. And we're -- that's the case, whether you're North America, South America or Europe, Asia. The snacking side of it is continuing to grow. I noted Asia's numbers. We just approved again on Monday additional capacity for our Malaysian operation. We've got new capacity because of support and higher demand going into Brazil. Europe, it's the COVID story, but it's also the sustainability. As we all know, Europe is ahead of really the rest of the world in terms of how serious they're taking sustainability. And right or wrong, there is just a movement against plastics and even other formats that are falling into our sales volumes. So we've talked about can packaging, and I should note that can packaging, this acquisition, while it was a EUR 30 million turnover business, our attraction was their technology. They make their own equipment. It's proprietary patented solutions. And that's snacks. It's -- I saw a presentation the other day, where we've got the full of about 100 million new units. And you name it, and there's very few snacks. It's folks that are in a plastic container. Even in one example, a metal container that has a big plastic lift, they don't want the plastic overcap. Even though it's separatable, you can put it, and I don't get it, but we have a paper overcap now that we can reline. So really, I feel extremely bullish about the things that we're seeing, both trend-wise coming out of COVID and longer term as it relates to sustainability.

Good. It looks like we're out of time. Again, Howard, Roger, thank you guys for participation this year. If we have anything else, we'll get a hold of you, Roger. Thank you.

All right. Well, Gabe, really appreciate it. Thanks for all of you for taking time today.