Sonoco Products Company (SON) Earnings Call Transcript & Summary

Good morning. We're moving on along here at the Deutsche Bank Global Industrials and Materials Conference. I'm Kyle White, the lead analyst for Paper & Packaging here at Deutsche Bank. Very excited to have Rob Dillard, the CFO of Sonoco here for our next presentation. I think Rob, you're going to give a little -- go through the slide deck in 15 minutes, and then we'll jump in to Q&A afterwards. [Operator Instructions]. With that, thank you for being here, and I'll hand it over to you.

Yes. Thanks. I appreciate it. And thanks for coming out. Good morning. I want to give you a quick update on Sonoco quickly. A couple of slides here. So Sonoco, if you don't know it as a global diversified packaging company. I think the most interesting thing there is just how diversified we are and how differentiating that is. And if you think about it, really the driver there is just the solutions applications and how we think about the businesses we're in. It really is solutions-oriented instead of being substrate oriented or end market oriented. We really think about a couple of core things when we think about the business and what we want the portfolio to look like. We think about material science and the ability to really drive differentiation and understanding of materials. We think about packaging functionality in terms of what we think is high packaging functionality. So we like packages that do a lot where we can add a lot of value and then get value for adding that value. And we also have a very specific and intense operating model that we really like businesses where we -- when we view the operating model, we like process manufacturing like really high value-added manufacturing that's something that's really core to what we do. And then increasingly, you'll see we are really thinking about sustainability principles and how we can loop that into the strategy and the portfolio more and more. So the solutions orientation and the diversification that you see in our portfolio is really actually quite intentional based on those principles and it's led to a pretty unique portfolio that's performing really well in this environment. One other thing you can see here is that, inherently, that intentionality about solutions and being diversified has really led to a fair amount of geographic diversification as well and a relatively diverse facilities footprint as well. Historically, we've been a little bit less oriented in North America as we've tended to work with our customers on expanding geographically. We've always felt like we would expand from positions of strength. With the Ball Metalpack acquisition that we did last year, the North American exposure has expanded. But we really think about Europe as an area where sustainability really has great trends and where we're driving really good growth where Latin America is actually one of our most profitable and cash-efficient geographies where APAC, especially and consumers are one of our highest growth areas. So we do kind of lean into those areas and think really expansively about what we can do there. We've been on a journey to really transform this 124-year company over the last several years. And it's really driven by these 4 trends. One was really focusing the portfolio on what we've called fewer bigger businesses. It didn't mean that we wanted to get rid of businesses intentionally, it meant that we wanted to have businesses with scale such that when we're actually executing to these centers of excellence or areas that we're really leaning into operationally that we can drive really meaningful value there. So we would rather have $1 billion or $2 billion businesses that we can drive 10% improvement on as opposed to $200 million businesses that were driving 10% improvements on. And that's led to thinking more expansively about footprint optimization about kind of managing the businesses on systems, so you can get synergies through logistics and purchasing and things like that. It also meant that last year, we did a really meaningful restructuring about how we run the business. And it was less about taking costs out and more about making us more agile and efficient. So we reduced layers and increased spans of control and really simplified the organization and an intentional effort to get really oriented to what we're calling the integrated businesses, which are the fewer bigger businesses that we can really drive value through. And we're setting up centers of excellence that are really discrete in order to drive things like supply chain and commercial excellence and global business services and through those entities. So there's a lot of opportunity, a lot of effort now driving through those integrated businesses even more than before through a really intensive operating model. And the third one is 3 years ago, we really said is there more opportunity to invest in the business and what are the kinds of returns that we could get if we really leaned in. And we realized that there was a really meaningful opportunity. There was a backlog of really high-return capital investment opportunities. And so what we've done over the last couple of years is we've slowly in a very disciplined way, ratchet it up the capital expenditures in order to drive better productivity and seed growth opportunities. And that's been really effective. You'll see that in the results, we're starting to see those -- the benefits of those investments. I think in past year in 2022 was the first year where you really saw it pop. This year, we'll continue to see that and it's kind of underlying the performance improvement that we've seen. And the last, the fourth one, it's really kind of become an overriding theme for us and a lot of packaging companies, is just really thinking about ESG and sustainability in the right way as our customers are starting to really align their growth strategies around ESG and sustainability efforts we've been there with the right solutions for them, and we see that as a long-term growth opportunity for us. Quickly, this is what I was talking about in terms of reordering the organization. We've kind of moved our fewer bigger businesses into what we call the integrated businesses, which is our 2 core segments. It's really -- we think about it as 4 businesses. So the rigid paper containers, Metal Packaging, Flexibles. And then the global paper products, which is now we call Industrial Packaging. And we've got other businesses that are in this diversified segment that we're running in a much more agile, I would say, entrepreneurial way where there is a little bit less burden from corporate, and they're really kind of getting pushed to drive cost out and drive customer solutions to drive growth in the right way. So we're really investing in growth, as I said, CapEx has gone up about $100 million in the last 3 years. The real kind of momentum case for this was Project Horizon, which was a recapitalization of our Hartsville Paper Mill Complex. That was completed last year in the third quarter and has kind of been ramping up over the last 6 months. It's on track. We expect to get really good returns from that. And it's the second step actually in a long-term improvement plan for our paper portfolio of which shutting down the Hutchinson paper mill was part of that. So we feel really good about the long-term prospects for improved profitability in our URB paper mill system and then also really kind of covering as many of those tons through our integrated model as possible. The Flexible business, we've really leaned in there as we see that as a growth opportunity, but a growth opportunity where you can get the right margins. And so we've been investing more in that business over the last couple of years, and that's what the $60 million is over the last several years. Rigid paper containers really is going to be the growth catalyst for our business going forward. It's a business that's on the right side of a lot of sustainability trends. We've seen this in Europe for a number of years and have really been investing behind it and seen mid- to high single-digit growth in that business for the last several years. We expect to see that type of growth globally, and we're investing behind that. And then Metal Cans is a business, as I said, that when we did that acquisition that fit our strategy really well. There was a really nice investment trend behind that business before we bought it. So they did about $200 million in CapEx in the preceding 3 years. And this -- we knew that the CapEx was going to come off. So last year, where the target was more like $25 million, and we feel like that's really nice sustainable level, but it will also continue to drive really meaningful profitability improvements going forward. You can see sustainability really is becoming a trend that's driving our organic growth now. And these are 3 examples, the top one, One More Day, this is an all paper or almost all paper solution that we got from our Can Packaging acquisition, really innovative kind of short run, high-quality solutions that we can take all over the world at -- in quicker time than we could do on a long-run system. So it's a really nice agile application to get sustainable solutions to customers quicker. Bisto is an application where they're one of the first users of our all paper long run fast speed can, which has been really well received in Europe. And then this last one was what we're calling a paper blister, which is replacing a plastic blister at retail with a paper application that has been really well received. Continuing to invest in the business really is, M&A is a huge part of what we're doing as we think about reshaping the portfolio and getting behind bigger businesses. We do have some businesses that we've said are great businesses, but we may not be the one to scale them or we may not even be the right owner. I think that the thing that we're really investing behind though is these ones that could be part of this fewer bigger businesses strategy, Metal Packaging, as we discussed, one that we're really leaning in on may not be any near-term opportunities there to further do things, but it's something that we were really intent on improving that industry. Skjern Paper is a continuation of both sustainability and improving our position in Europe. That's a mill that has a really kind of modern and elegant solution and -- for energy, they actually supply energy to the bulk of the near by town and are super efficient in doing it. And so we think that, that's a model for what paper mills can be. RTS is this acquisition that we're expecting to close in the second half of this year. I'm really excited about that one. It's a long-term JV that we've had with WestRock. We've been great partners but it was more core to us than to them, especially as we were intentional on being uncovering those tons more effectively in our mill system and also adding the really highly capable Chattanooga Mill. So really excited about seeing that on close. We're anticipating it to close in the second half of this year and really hopeful for that process to end. ESG has become a really meaningful part of how we think about the business. I would say it's a little different at Sonoco because with like everything we do, we really try to drive it from the bottoms up and have this philosophy of people build businesses by doing the right thing. And so we've always kind of really pushed values through the business from the people and so this was just really natural for us to just kind of put a framework around it and how we think about it and really govern it in a more intentional way. And the last is sustainability. So as I said, it's going to be a real growth driver for us. Converting composite cans into all-paper solutions, doing things like paper blisters and making our resin-based packaging more environmentally friendly and recyclable as a big push, and we feel really good about that. Converting Flexibles from resin-based to paper-based, there's a real opportunity that we're exploring. So we feel really good about that. And then even on the top right corner for you as our Natrellis bowl, which is the gas-based molded fiber bowl that we're doing in a joint venture partnership. We've got other really interesting investments like [indiscernible] paper which is a protective solution based on paper that's modified in the right way to be a really good protective package or a thermal package. So a lot of really interesting things going on there, a lot of kind of things that are starting that are may be subscale right now, but that we feel like in the long run will be really interesting. And so this is how we've really performed. And I think that last year was the year when the rubber kind of hit the road. We've been working on this for several years now, but I think that it takes time for pricing to kind of come through with volume, which was the challenge with COVID in '20 and '21. It takes time for kind of productivity hit from capital investments, which is what we saw in the last couple of years. And then it's taken time for kind of the new organic growth to really hit and so I think last year was the first year that they all kind of hit at the same time, and we saw this spike in improvement. And about half of that improvement was the Ball Metalpack acquisition, which had some metal price overlap and then the other half was just really this operational improvement all coming at once. So we feel like this is imminently sustainable. If you put the metal price overlap out of the $5.85, we'd be well into the $6 EPS range. So we feel really good about where we are right now and the base that we're building for future improvements. So in summary, Sonoco, we really think of ourselves as a leader in the diversified and sustainable packaging areas. We're continuing to transform the portfolio through M&A. It will be a big part of what we're doing, but we're being very disciplined about it and making sure that the right things come to us. We're very focused on kind of our operating margins and managing our operating system in the right way, and we're being really disciplined with our capital allocation, where we're focused on maintaining the dividend and paying the right dividend payout and also maintaining our investment-grade capital rating. So we're committed to that as well as our ESG initiatives and the sustainability, which is a really meaningful part of what we're going to do going forward.

Thanks for that, Rob. I guess just to kind of start it off here on the Q&A. You guys talked about some of the diversification that you have. You touched some industrial markets. You touched consumer markets. So maybe just broadly, what are you seeing here today as it relates to the economic backdrop on the industrial side as well as the consumer?

Yes, really interesting environment. I would say, normally, we see in our industrial markets, we see economic kind of softening about 1 to 2 quarters ahead, and we started to see the economic softening in the back half of the third quarter. So our base case for this year was that we'd see kind of a weakening, maybe even a recession at the first half of this year and then some slight recovery in the back half of this year. And we've been surprised by, one, how resilient the consumers have been but also how persistent kind of inventories have been and how much destocking there still is required in the system. I think that also there's a fair amount of insecurity at the consumer level and the consumer goods level about how much more can the consumer take, prices have kind of been elevated for so long and when are we going to have to start to really promote again and take price in order to keep share. I think that, that's we're on the verge of starting to see some of that. So our base case is now that we'll probably see something in the back half of this year, a light recession or even more economic disruption and that will -- the recovery will be in next year now. So pushed off 6 months or so, it hasn't changed kind of our long-term position or our investment in the business, but it has changed our perspective for what this year is going to be and how people and we think about the second half of the year?

Yes. And you guys have become a little bit more defensive with your portfolio with the acquisition of the food can space. Even going into this year, you're targeting mid-single-digit growth for that business, and I think that's what you've achieved in 1Q, which is pretty strong for food cans historically. Maybe talk about what is driving that growth? What gives you optimism that you guys can see that level of growth in the food can space?

Yes. So food cans are a really interesting sector because there's this massive buildup in inventory in different parts of the year and they even kind of build up certain really seasonal products build up a whole year's worth of sales and then they sell them out through that point forward. So you can -- you have the opportunity for real inventory builds and even the packers never want to be out of cans. And so they'll even build kind of meaningful inventory builds up to a whole year's worth of inventory. And so there's a lot of opportunity for inventory builds and inventory glut. I'd say right now, what we're seeing is we have seen a sell-off in the inventory in the food side, which is driving kind of restocking that which is different. And that's driven kind of this mid-single-digit growth in food cans. It's been pretty persistent. I think that the second half of this year will probably be a little weaker, but it will still be up because most of the growers probably didn't plan as much this year as they did in the previous years in order to kind of manage the inventory situation.

Got it. Any kind of early thoughts as it relates to the pack harvest later this year.

No. Well, we think it will be a little wider than it was last year just because people weren't packing as much and there was some weather disruptions in the second half of last year, but we think it will still be a strong season.

Yes. Offsetting some of the growth that you're seeing in food cans, you had some destocking on the aerosol side. Has that largely played out? Or is that still persisting?

It will persist for a while. So our aerosol businesses are a little bit more levered to spray paint and household cleaning. And so those are 2 areas that -- where there's obviously a lot of opportunity for inventory builds. And I think that those customers have seen some inventory build. And they're also kind of playing through some interesting pricing dynamics where there's been some pretty meaningful share gains at the retail level just because of who's holding price longer.

Yes. Going to the Rigid Paper Containers, one of your core businesses that you're focused on. You talked about mid-single-digit growth or even potentially high single-digit growth there. Is that primarily driven by sustainability and customers shifting away from a plastic-based substrate into your fiber Rigid Paper Container? And is it -- are you seeing similar growth in the U.S. as you are in Europe? Maybe just talk about that dynamic.

Yes. So we're incredibly bullish on the long-term trends for Rigid Paper Containers. We've seen this trend for a number of years in Europe where that business has grown with the acquisition there, but also organically from $50 million to $450 million over the last 10 years or so. So we do see a secular trend where consumers actually are increasingly purchasing stack chips as an example. That trend has actually persisted in North America, and the business has been kind of flat from a volume perspective because there's some legacy end markets that have been falling off in that period while stack chips has been growing. And so there was a leveling off and kind of a neutralization of the growth. I think we've seen that those areas that were declining are probably leveling off at a low level now. And so the growth in stack chips is going to overtake it. And that's where we'll see kind of the growth come through in that business going forward. There is a really meaningful push into that area and increasing global competition. And so we've seen kind of 20% growth in Asia for a number of years and expect to continue to see that. We've seen kind of high single-digit growth in Europe and expect to continue to see that. And so we expect to see growth in North America on a kind of commensurate level. The challenge right now is actually getting plants built and machinery on the ground, which used to be year timeline and now it's 18 months or maybe even longer. So that's -- these are kind of long-dated prospects of growth that are in place now.

Yes. I thought we were getting past those difficult supply chain, so it's getting easier. But maybe for those that are newer to the story, what's kind of the market share dynamics as it relates to Rigid Paper Containers globally or U.S.?

Yes. I mean we feel like Rigid Paper Containers are part of a broader market of all paper -- of all containers that are rigid. We certainly lose business to Flexibles and rigid plastic, but we're definitely the predominant supplier globally of Rigid Paper Containers and feel really good about our technological advantage, our ability to supply the right paper to the right plants, and we've got really long durable partnerships with all of our customers there.

As we think about supply/demand for URB, you've internalized some of URB to make Rigid Paper Containers, if this continues to be kind of a growth catalyst, is there a way to frame how much of your URB production is internalized for that end market just as we're trying to think about how it helps to balance URB markets?

It's not as much as we would hope. It's just not as heavier user of URB. We did buy the Skjern mill to internalize that demand and have more surety of supply. And the U.S. shutting down the Hutchinson mill was partially oriented to getting the right supply dynamics for the RPC business. It's 5% of the total offtake. We do have a pretty intentional effort to cover more of the URB tons and feel like we're well on the way to doing that. The RTS acquisition will be a great next step in that. And we think that, that will improve our ability to supply those customers.

Yes. With RTS closing, you made some optimization with Hutchinson. We will get the Chattanooga mill. Does that provide for further optimization opportunities? Or are you happy with the footprint.

Yes, the Hutch -- so we've had 2 plans to improve the mill system. There was one that we kind of on our fleet called [indiscernible], which is the North American Operation Improvement Strategy. That one has gone through and completed and then Horizon was kind of the second step, which was all pretty predetermined once we initiated that. Hutchinson was always part of that plan. So we're -- now we're doing planning. There's really intense kind of modeling in terms of scenario analysis on all the mills and what's the optimal way to supply all of your endpoints so that we're doing that now. And it will probably lead to some more actions, but we feel really good about our -- how balanced that market is and how competitive it is at this point.

What are you guys seeing on the Europe in terms of stabilization of demand globally, where our backlog is at?

It's stable but at a low level. We've been since in North America, which is our predominant market, we've been stabilized at levels that were pretty equivalent to 2008 or even May of 2020 in COVID that I think that sounds pretty negative. But in reality, it's kind of like an 8% year-over-year difference. There isn't that much variance in the demand. But at those levels, our utilization is now in kind of the mid-80s which, believe it or not, you can still, at this pricing levels, you can still make kind of really strong margins and URB at that kind of utilization. We feel like that's going to continue until we see a little bit more demand recovery, and that was expected in the second half? Or just while we see kind of green shoots every now and then, we haven't seen kind of a continued intensifying of demand. So we expect that to happen in the latter half of the year.

Yes. mid-80s, is that on a global basis or U.S. a little bit higher versus where...

U.S. a little bit higher. Asia is obviously really low because of China though if you went mill by mill in Indonesia, we're actually really, really strong right now. In Europe, we have a couple of mills that are going through some capital projects, which are driving their utilization down a little bit. In the U.S. we're probably mid-80s. But -- and part of that is, I'd say, in the last 3 months, part of that has been because we had a backlog of maintenance that we built up last year when we were running so heavy. And so we've been taking this opportunity to do a lot of maintenance, which adds cost, but also creates downtime. And so we're through that and we'll see that kind of cycle out in the next couple of months.

Yes. Small exposure for you, but you mentioned China and Asia, how things progress there? Any signs of optimism as it relates to this much talked about reopening.

Not really, not on the paper mill side, I think that, that market was always so unstructured that it was uneconomical and really not a really high return mill. And so I mean, we essentially make no money there. And so we're thinking a lot about what our options are in the long run.

Yes. You guys have done a really good job of pushing price and cost and last year, a really strong number. This year, you had the headwind from the metal pricing in the first quarter. If we strip out that, how are you thinking about price cost for the full year for you guys? You have some headwinds maybe in the back half as it relates to URB timing, but...

Yes, if you stripped out the metal price overall, we'd probably still be a little negative on price cost year-over-year, but more in the neighborhood of $20 million or $30 million on the whole business for the whole year, and that would be almost entirely oriented to what we're anticipating, not what we've seen yet as kind of a deterioration in the industrial business -- the consumer business. So RPC is still getting price cost through price, I would say Flexibles is probably flattish on price cost at this point, price offsetting cost and metal obviously, it's a really heavy on the overlap. And so if you -- it's interesting that we had always targeted 16% as the EBITDA target. But if you had stripped out either the metal business or just the metal price overlap, we would have been in the mid-17% range in the first quarter. So kind of continually stepping up the margins partially but due to that price cost improvement.

Yes. And then productivity was a bit better than what we were anticipating for 1Q, at least on our side. I think it was around $20 million or so. What are you thinking for productivity for the balance of the year? And then what's in the pipeline from capital investments internally, you have these big projects similar to Project Horizon? Or is it just a bunch of smaller projects that's going to continue to drive the global productivity?

Yes. There's meaningful effort on all fronts, so procurement, kind of capital-driven productivity and then also manufacturing productivity to really drive productivity through the business. $20 million was a good result for the first quarter as we are kind of still ramping through a lot of those initiatives. I would say procurement is actually really driving a really meaningful amount of productivity. And I think that, that alone will get us really close to our $90 million to $100 million target for the year. We're really optimistic about the opportunity to drive some more capital and manufacturing improvements through the balance of the year. And then we think that, that's really going to take even more hold next year. So we're really excited about that.

Yes. Maybe I'll stop and see if there's any questions from the audience. If not, I will continue on. So a big focus for Sonoco is on the 4 core businesses that you guys have talked about becoming more focused on those businesses. Maybe just talk about what that means for the other businesses. I think you made the comment that it doesn't necessarily mean that you're looking to divest them, but you also made a comment that maybe if there's a better owner for it, you would look at that, too. Is that something that you guys are exploring right now in terms of potential divestitures of this?

I mean, so the model really is to have these big businesses that we can really lean into and really improve through these centers of excellence that we've set up. We're starting to see really meaningful improvement driven by that. We think that we're going to continue to see that. So we think that, that model is working. The diversified businesses were ones where we just didn't think we would get the scale and the leverage by having these big corporate initiatives driving to these smaller businesses. And so there's intensive efforts to, one, improve those businesses and see if they can be scaled or consolidated in a ways that they become scale. So we are the #3 Thermoformer in the United States and feel really good about that position, but we've run it as 4 distinct businesses. So that's an example of how we think about those businesses and what we could do there, and we are consolidating those businesses in some way. But in other ways, some of those businesses in the diversified segment, we probably aren't the right owner in the long term, but we're being really thoughtful about how should we do that and what is the long term because there are a lot of -- as you can see in the first quarter, the performance improvement there just by saying, let's not run this in quite a heavier way. Let's take as much cost out as we can. Let's be really oriented to kind of growth and price in the right way that you can really see kind of meaningful improvements in performance in some of those businesses and we've been doing that with really great success. And so there's an intentional effort to continue to focus on these core businesses, and we know that part of that effort means that we don't want to be distracted by these other businesses, but there's still a lot of opportunity there. So I think the other thing is, the M&A market is still really difficult and that both the financing environment kind of shutting down a lot of prospective acquisitions from sponsors. And then also a little bit of the chilling effect of the government scrutiny on any type of M&A has led to a little more dampened environment to sell businesses and has inhibited our ability to really meaningfully clean up the portfolio in the right way.

Yes. If you were to happen to have the divestiture, what do you think you would use proceeds for related to your capital allocation?

Yes. Good question. We think a lot about the capital allocation. Obviously, the dividend always comes first. No intention to do a special dividend. We just don't think that, that really drives value, but we are really thoughtful about making sure that our shareholders are rewarded for over the long run through the dividend, and we feel good about kind of the raise we just did. We want to keep that yield in a really competitive framework, but also want to have share price appreciation as a big part of that TSR, so we think about what share repurchases should be, and we want that to be a programmatic plan, not kind of episodic, and we'll think about that in a pretty meaningful way. I would say, until we get to that point, we're probably going to be more focused on paying down some debt and managing the rating. I think the rating agencies would like to see us just kind of [indiscernible] pay off a little bit of debt just to take the negative outlook away from S&P and really solidify the BBB rating.

Yes. Last question here. What's the right optimal leverage target that you see for Sonoco in this environment? And then with that, if the right acquisition came to you, I think you guys are levered at 2.7x at the end of last quarter. Great acquisition came to you and one of your core businesses, where -- how high would you be willing to take leverage?

Yes, good question. So we don't have a specific leverage target. It just hasn't been a policy. The policy really is we want to keep our investment-grade rating and there's relatively loose framework around that. They want you to be kind of in the 3x or less on an adjusted basis. They are over the long run. And so the long run is kind of a long ways out of what we manage to that. We do feel like we have opportunity above where we are in a pretty meaningful way. And so we feel like we've got a fair amount of opportunity to cover the right way, but keep our conservative capital structure.

Sounds good. Well, I really appreciate your participation. Thank you for being here.

Yes, thanks. Thanks for having me.