WestRock Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
May 5, 2022

There are 14 speakers on the call.

Operator

Good morning, and welcome to the WestRock Company Fiscal Q2 2022 Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Rob Quartaro, Senior Vice President of Investor Relations.

Operator

Please go ahead.

Speaker 1

Good morning, and thank you for joining our 2nd fiscal quarter 2022 earnings call. We issued our press release this morning and posted the accompanying presentation to the Investor Relations section of our website. They can be accessed at ir.westrock.com Or via a link on the application you are using to view this webcast. With me on today's call are WestRock's Chief Executive Officer, David Sewell And our Chief Financial Officer, Alex Pease. Following our prepared comments, we will open the call for a question and answer session.

Speaker 1

During today's call, we will be making forward looking statements involving our plans, expectations, estimates and beliefs related to future events. These statements may involve a number of risks and uncertainties that could cause actual results to differ materially from those we discuss during the call. We describe these risks and uncertainties in our filings with the SEC, including our 10 ks for the fiscal year ended September 30, 2021. We will also be referencing non GAAP financial measures during the call. We have provided reconciliations of these non GAAP measures to the most directly comparable GAAP measures In the appendix of the slide presentation.

Speaker 1

As mentioned previously, the slide presentation is available on our website. With that, I'll now turn it over to you, David.

Speaker 2

Thank you, Rob, and thank you all for joining our earnings call today. To begin our call, I'll provide a brief summary of the recent actions we've taken and provide an overview of our fiscal second quarter results. Following that, our CFO, Alex Pease will provide a deep dive into the quarterly performance for our segments and other critical financial performance. He'll also provide guidance for the fiscal Q3 and the full year. We will then move to Q and A to answer any questions you may have.

Speaker 2

Over the past year, we've been making significant progress in our efforts to transform WestRock into the very best paper and packaging company. We have aligned our mills into 1 organization and updated our operating segments to provide increased transparency and better reflect How we manage our business. We've established a global supply chain organization to reduce costs and drive efficiencies. We've launched the WestRock operating system to standardize reporting and drive greater productivity. And we've completed a strategic review of our assets, Taking our first step to rationalize our portfolio and drive improved return on invested capital.

Speaker 2

From a balance sheet and capital allocation perspective, We achieved our initial leverage target last year. At the same time, we've increased our dividend 25% And completed approximately $700,000,000 of share repurchases over the last 12 months. While we already have a lot to be proud of, we are only Just beginning. Turning to Slide 4. Today, we reported strong results with record 2nd fiscal quarter consolidated adjusted EBITDA and adjusted EPS above the high end of our guidance.

Speaker 2

I want to take just a minute to thank all of our team members at WestRock for their hard work And helping us achieve this success. 2nd quarter sales were a record $5,400,000,000 up 21% year over year. We delivered consolidated adjusted EBITDA of $854,000,000 up 33% year over year And adjusted earnings per share of $1.17 more than double the year ago numbers. We achieved these outstanding results During another quarter of heavy scheduled maintenance and I'm happy to report that our maintenance projects were completed successfully. We have already finished the majority of our planned maintenance for this fiscal year.

Speaker 2

We continue to see robust demand and strong backlogs across our entire system, while also navigating the tight labor market and supply chain disruptions. As the Q2 progressed, we experienced declines in COVID Related absenteeism and improved production levels at our converting facilities. We exited the quarter with appropriate inventory levels As we enter the stronger demand season in the back half of the year, we ended the quarter with net leverage of 2.34 times while aggressively buying back stock. We have nearly completed the $500,000,000 buyback target that we spoke about last quarter and expect to finish by the end of May. Once completed, we will have repurchased approximately $700,000,000 of our stock over the last 12 months.

Speaker 2

Today, we also announced that our Board has authorized an additional 25,000,000 shares for repurchase, Representing approximately 10% of our outstanding shares. Looking ahead, we will continue to return capital to our shareholders Through a sustainable and growing dividend as well as opportunistic share repurchases. Turning to Slide 5, our previously published price increases Have more than offset unprecedented inflation in fiber, labor, freight, energy and chemicals. We are still implementing containerboard and boxboard price increases and we expect these price realizations to more than offset inflation for the foreseeable future. On the next slide, as we've previously discussed, we completed a portfolio review and have identified assets that don't meet our return thresholds We're aligned with our strategic priorities.

Speaker 2

In April, we announced the decision to close our Panama City mill as a first step in this portfolio refinement effort. I am incredibly grateful for our mill employees and their contributions to building our company. We are continuing to support our employees during this difficult transition by offering opportunities at other facilities and providing outplacement assistance. This is never an easy decision. However, given the significant capital investments required to keep the mill operational, We did not see a path to achieving our ROIC targets.

Speaker 2

We are also strategically reducing our exposure to the fluff pulp market and will direct our resources toward more attractive end markets. Our Panama City mill provided containerboard capacity of 353,000 tons And pulp capacity of 292,000 tons. We expect to shift some containerboard grades to other mills within our network. As a result of the closure, we expect approximately $450,000,000 of one time costs, of which Approximately 3 fourths are non cash. We recognized $355,000,000 of expense in the 2nd quarter And we expect to incur the remainder over the next several years.

Speaker 2

Going forward, we expect ongoing EBITDA to be negatively impacted By approximately $65,000,000 annually. Before I turn it over to Alex to discuss the detailed results for the quarter, I wanted to remind you once again about our Investor Day coming up next week. We are looking forward to seeing many of you in New York where we will outline our long term strategy and goals. We have a great story to share with you and you will get a chance to hear from many members of our talented management team. As a preview and part of our updated capital allocation strategy, one of our goals will be to reduce our leverage even further with a new net leverage target 1.75 times to 2.25 times.

Speaker 2

We remain committed to prudent balance sheet management And we are maintaining our free cash flow guidance of over $1,300,000,000 in fiscal 2022. On Investor Day, we'll also share information about

Speaker 3

the many efforts underway across WestRock to focus on high value markets, Enhance our margins and improve our productivity. Now I'll turn it over to Alex to review our results. Thanks, David. Moving to our consolidated quarterly results on Slide 7. 2nd quarter revenue increased 21% to $5,400,000,000 and consolidated Adjusted EBITDA increased 33 percent to $854,000,000 Consolidated adjusted EBITDA margin was 15.9%, up 150 basis points year over year.

Speaker 3

Our diverse portfolio enables us to deliver higher value solutions to our customers, Capturing stronger price with enhanced product mix. Price and mix positively contributed over $700,000,000 year over year. We also saw an $88,000,000 benefit as last year we were negatively impacted by the ransomware incident and weather. However, continuing inflation headwinds in fiber, labor, freight, energy and chemicals, along with foreign exchange and other challenges, largely offset the benefits. As David noted, we experienced significant improvement in COVID related absenteeism as the quarter progressed, but still see continuing risks in logistics and other input costs.

Speaker 3

We successfully executed significant planned maintenance downtime during the quarter. And looking ahead, we expect significantly less planned downtime through the remainder of the year. Turning to Slide 8. Corrugated Packaging sales were $2,000,000,000 an increase of $281,000,000 or 14% year over year. Adjusted EBITDA increased $8,000,000 Or 2%, though adjusted EBITDA margin declined 180 basis points to 14.7% as we continued to work Through the impact of labor issues that we experienced early in the quarter.

Speaker 3

Strong pricing and mix contributed $275,000,000 but was offset $200,000,000 of inflation and an $80,000,000 decline in productivity. Productivity was negatively impacted by heavy mill maintenance and labor challenges during the quarter. We experienced continued inflation in fiber, labor, freight, energy and chemicals during the quarter. In addition, as mentioned, COVID related absenteeism negatively impacted converting operations in January February. However, we experienced significant improvement as the quarter progressed.

Speaker 3

Favorable comparisons to last year's weather and ransomware events also benefited adjusted EBITDA by $20,000,000 year over year. Per day, North American box shipments were slightly softer year over year, mainly due to labor issues early in the quarter. However, as we exited the quarter, our run rate Significantly improved and we're currently selling everything we can produce. When looking at our end markets, we're seeing a shift due to reopening as the pandemic eases. Our pure play e commerce volumes are softer year over year, but are being more than offset by expanding omnichannel retail volume.

Speaker 3

We are also seeing shifting buying patterns with pizza volumes declining as people return to restaurants, but growth in areas like bakery. Geographically, our Brazil business outperformed in a challenging market, producing EBITDA margins over 30% across our combined Corrugated and Paper segments. Longer term, we continue to see significant opportunities in Latin America. Overall, demand throughout our corrugated business remains strong And our shipments have been limited by production capacity rather than customer demand. This strength demonstrates the value we provide our customers and our flexibility serve a diverse range of end markets.

Speaker 3

We remain optimistic for the remainder of the fiscal year. Our backlogs are healthy and demand is solid. We're also in the early stages of implementing the previously published March containerboard price increase. Productivity has improved, And we exited the quarter with March EBITDA margins of approximately 17%. Looking ahead, we remain relentlessly focused on improving our margins as we continue The WestRock operating system.

Speaker 3

Turning to the Consumer Packaging business on Slide 9. Sales increased $170,000,000 or 16 percent to $1,250,000,000 Adjusted EBITDA increased $42,000,000 or 25 percent And adjusted EBITDA margin was 16.5%, an increase of 130 basis points year over year. Higher volumes added $31,000,000 and strong price and mix contributed $111,000,000 These volumes more than offset a negative impact $93,000,000 due to inflation, primarily in freight, energy and labor. Plastic replacements and other transitions to sustainable packaging provide continued attractive growth opportunities. Our broad portfolio and product innovations and Our broad portfolio and product innovations enable us to provide unique solutions and help our customers reduce their environmental footprint.

Speaker 3

Our current run rate for plastic replacements revenue is now exceeding $300,000,000 annually. We are executing well and we continue to implement the previously published price across all consumer grades. We have more demand than we can meet with backlogs of 6 to 8 weeks. We saw particular strength in beverage and retail food during the quarter. Turning to Slide 10.

Speaker 3

Global Paper revenue increased $407,000,000 or 36 percent to $1,500,000,000 Adjusted EBITDA increased $149,000,000 or 93%, and adjusted EBITDA margin increased 600 basis points to 20.1%. It's important to note that this strong margin would have been reported in our Corrugated and Consumer segments under our prior reporting structure. Our paper business continues to benefit from previously announced pricing realization and higher volumes, partially offset by energy, freight and other costs. Price and mix contributed $311,000,000 to adjusted EBITDA, while inflation negatively impacted results by $166,000,000 Favorable comparisons to last year's Q2, which

Speaker 4

had the

Speaker 3

impact of winter weather and ransomware event, also benefited adjusted EBITDA by $63,000,000 year over year. We continue to see strong demand for our paper products in both independent domestic and export markets, though logistics continued to be impacted By ongoing supply chain disruptions, our Global Paper business is a competitive differentiator, enabling us to strategically balance our production and provide flexibility adapt to current market trends. We remain optimistic for our paper business through the remainder of the fiscal year due to our strong backlogs And the realization of previously published price increases. Next, our distribution results are on Slide 11. Our distribution performance was strong with revenue increasing 29% year over year to $362,000,000 Adjusted EBITDA more than doubled to $28,000,000 Our impressive results were driven by robust demand and strong execution across our distribution network.

Speaker 3

Results also benefited from fulfillment of a large healthcare order. Turning to Slide 12. During the quarter, We generated $213,000,000 in adjusted free cash flow, up significantly from the previous year's levels as last year was negatively impacted by the ransomware incident. We still expect fiscal year 'twenty two to be a very strong year for cash generation, with adjusted free cash flow of more than $1,300,000,000 for the year, Making this year the 7th straight year of adjusted free cash flow above $1,000,000,000 Additionally, though we aggressively repurchased shares in the quarter, Our leverage ended the quarter at 2.34 times, approaching our new long term targeted net leverage ratio of 1.75 times to 2.25 times. Turning to Slide 13 and our financial guidance for the Q3.

Speaker 3

We continue to implement all previously published price increases. We still have approximately 54,000 tons of scheduled downtime across our system in the Q3. This is due to delays in mill maintenance From earlier in fiscal 2021 along with our originally planned outages, we are early in the process of evaluating our 2023 maintenance schedule, And we are considering shifting maintenance forward into fiscal 2022. Our forecast for Q3 consolidated adjusted EBITDA is $930,000,000 $990,000,000 and adjusted EPS of $1.36 to $1.54 Some assumptions behind our outlook Include OCC costs roughly flat quarter over quarter, natural gas costs up approximately $2 per MMBtu sequentially, Continued inflation in freight and logistics expense and a tax rate between 24% 26%. On Slide 14, We're also updating our full year guidance, both tightening the range and raising the low end.

Speaker 3

We now expect to achieve 3.5 $3,700,000,000 in consolidated adjusted EBITDA and $4.75 to $5.35 And adjusted EPS during fiscal 2022. Looking forward, given the strength of our differentiated solutions, we're Positioned well for sales, earnings and free cash flow growth this year and beyond. I'll now turn it back to David to conclude before we move to Q and A.

Speaker 2

Thank you, Alex. Due to the hard work of our teammates, we had an outstanding quarter and we are well positioned for the remainder of the year and beyond. I look forward to meeting many of you next week as we provide a deep dive into our long term strategy and goals at our 2022 Investor Day in New York. I am incredibly excited about our future and I can't wait to share our plans with you. Thank you.

Speaker 2

And with that, Rob, let's move to Q and A.

Speaker 1

Thank you, David. Operator, may we take our first question?

Operator

We will now begin the question and answer session. At this time, we will pause momentarily to respond to our roster. Our first question will come from George Staphos with Bank of America. You may now go ahead.

Speaker 5

Hi, everyone. Good morning. Thanks for taking my questions and thanks for all the details. Lots to cover here guys and congratulations on the So I kind of apologize just asking kind of a shorter term question, but can you talk and provide a little bit more detail on what you're seeing early into The calendar Q2 in terms of box volumes and for that matter consumer volumes as well with the backup in particular on the cargo side of Volumes in 1Q being a bit soft, obviously there were a lot of supply chain issues. What are you seeing right now?

Speaker 5

And then I had a couple of quick follow ons.

Speaker 6

Good morning, George. Thanks for the question. We are still seeing very strong demand. And to break it down between consumer and corrugated, our corrugated demand was very strong throughout the quarter where we were challenged, As Alex mentioned in the earlier comments was we had significant COVID absenteeism actually disproportional To the rest of our business for whatever reason and our corrugated converting plants. And so we just did not get the production out that we needed.

Speaker 6

As the quarter went on and we say that we saw that COVID absenteeism reduce, we really started seeing much better Production rates to meet the demands of our customers. And as mentioned, we had a record run rate of the year in March. We saw the better productivity. The WestRock operating systems was able to start generating that productivity. So we saw the box production Much improved.

Speaker 6

We saw our margins much improved about 17% and we are seeing that strong demand continue into April. And on the consumer side, it's the same thing. We are basically in a sold out environment. That has not changed at all. Our backlogs are strong at 6 to 8 weeks.

Speaker 6

Our plastics replacement opportunities continue to expand. So we're working very hard on the innovation side. So we feel great about the demand of our business across all of our Business segments including Global Paper and that trend is continuing, which is why we took up the midpoint of our year.

Speaker 5

My other two questions, can you talk directionally about demand and any other factors non pricing obviously Related to your assumptions built into your guidance for the paper segment as we look out over the rest of the year, both in terms of domestic third party And export, what are you seeing in those markets? And then I know you might not want to get too far ahead of your Analyst Day next week, But can you talk directionally about some of the opportunities that you're seeing in productivity, whether it's Employee basis, SG and A, any color on that ahead of the conference call or excuse me, the Analyst Day would be helpful Good luck in the quarter.

Speaker 6

Thanks, George. So to answer your first question on our Global Paper business, This is one of the reasons why we wanted to split this business out from a reporting standpoint Just because of how strategic we view this business for our company, our ability to balance our entire portfolio, Our ability to flex manufacture to meet the changing market dynamics. And what our Global Paper business is able to do? And I'm going to Stop a little short because I'm really excited about our Investor Day and John O'Neill who runs that Global Paper business is going to talk about our Strategy, the segments and how we see the growth moving forward. But just at a higher level, This business allows us to get a global overview of the market dynamics.

Speaker 6

And with the broad portfolio of products That we're able to manufacture and recognizing what our packaging business needs are, that business is able to really take advantage And strategically position us, so we maximize value. And we see that Continuing to be a differentiator for us moving forward. You'll hear a lot more about that at our Investor Day next week. And George, I apologize, I can't remember what the second part of your question was.

Speaker 5

Just some thoughts on what you'll talk about in productivity Oh, yes. Opportunity

Speaker 4

you have.

Speaker 5

But just are you seeing growth in export or independent channels in the paper business in terms of what you're looking at for the year? Sorry about that. Thanks.

Speaker 6

Yes. No, that's my fault. So on the Global Paper business, we have seen a significant increase in export. But also, I mean, if you just look at our volumes, we had strong volumes. Our But also, I mean, if you just look at our volumes, we had strong volumes.

Speaker 6

Our domestic was very strong as well. Central America Has been a big growth lever for us. We're seeing nice growth in Europe as well, but our domestic business is also seeing growth. So it's really across the board. And as far as productivity, that's a point very close to home for me.

Speaker 6

We're really starting to get momentum on our productivity programs. We've built our global supply chain. We're now starting to get momentum around that. We've developed the WestRock operating system, which we'll talk more about Next week, which is a really important productivity driver from an operational standpoint as well as commercial standpoint. And then on key areas like SG and A that you referenced, as we build the shared services and centers of excellence, we've now got established.

Speaker 6

That's going to allow us to reduce and eliminate the redundancies of having siloed organizations. So you'll continue to see reduction in SG and A as we move forward, and we'll give insights in how we see Productivity and SG and A and the impact that's going to have on our margins as we move forward.

Speaker 5

Thank you very much.

Speaker 6

Thanks, Richard.

Operator

Our next question will come from Mark Weintraub with Seaport. You may now go ahead.

Speaker 7

Thank you. Congrats on a great quarter. And I do apologize, I had a little technical difficulty right at the beginning, But I'm pretty sure this wasn't covered. On Slide 5, we can see there's some pretty big differences in the amount of Pricing you've gotten in boxboard versus what you've gotten in containerboard to date. Can you provide any thoughts On that and relatedly, are you seeing or have you seen an ability this cycle to get Significantly more pricing into boxes than into containerboard.

Speaker 7

Has there been more than full pass And maybe talk a little bit about that if that's the case and whether or not that's a realistic expectation To have for the current March price increase in containerboard as well?

Speaker 6

So We it's an interesting question. We have not seen any material difference. So as we look at our published Price increases, we are executing those price increases In totality and where our contracts allows us to maximize. There may be a little bit of a difference in just volumes and how we're seeing that pricing flow through. Obviously, there's some contractual differences between the two businesses as well.

Speaker 6

But there's no material difference as far as Consumer versus corrugated and our ability to get prices, demand is very strong. Our customers understand The incredible inflationary pressure we're under. And we've just announced in the marketplace that's been published. It's been higher price increases published per se SBS of $400 a ton versus $200 a ton and announced Price increases published price increases in North American containerboard.

Speaker 7

Okay. And one quick follow-up. If and I know we talked about this in other context, But it strikes me that you guys report on a fiscal year basis, everybody else is on a calendar year basis. Given that we've had these price increases in motion and given just even just looking at the trajectory of your profits This year, it looks like the second half being a lot better than the first half. Is it fair to think that your first Fiscal quarter for next year or the 4th calendar quarter would likely be much stronger than that year ago period.

Speaker 7

So that if we were to Think about where your calendar 'twenty two earnings and cash generation would be, it would be substantially higher than The calendar of the prior year. And is there any way you can if it's a fair I don't know if you've had a chance to look at it and would be willing to share a perspective on How significant a difference it would be if that is indeed the case?

Speaker 6

Yes, Mark, thanks for that. We actually talk quite a bit about Fiscal year versus calendar year. And I think your assumption is spot on as we think about our setup For 2023 fiscal year 2023 and a very good start to that year.

Speaker 4

And I'll have Alex speak just a little bit more about that. Yes. So Mark, maybe the best way to answer your question is to just help you with the trajectory of pricing and the trajectory of Inflation because those are going to be the biggest kind of drivers in the model. So as we think about sort of the back half of the year, Sequentially, we're expecting about $130,000,000 of incremental flow through from previously published pricing. So that gets you to about $650,000,000 year over year.

Speaker 4

And part of the answer to your prior Question was also, you have to remember there's about a 3 to 6 month lag on containerboard pricing to flow through given the nature of the contracts and then there's about 6 to 9 month lag in the consumer business. So you'll see that pricing flow through accelerate as we get to the back half of the year. So that's the first point. On pricing, which absolutely reinforces what David said, that you'll see incremental pricing as you go from Q4 Of our fiscal year to Q4 of the calendar year and setting us up for 2023. On inflation, really all of the Significant inflation we've seen has mitigated quite dramatically, still at elevated rates, but mitigated dramatically.

Speaker 4

So if you think about Where we are year over year, on OCC, you're going to be up about 50% to $153 a ton. Virgin is going to be up incrementally, call it 10% year over year. Natural gas is up significantly from $3 to about almost $8 where we exit the year. And then freight continues to be up about 10%. So that's where what it looks like if you were to look at 'twenty one versus 'twenty two.

Speaker 4

But then if you were to look at Q2 versus Q4, It's largely flat in almost all of those dimensions with the exception of natural gas, which is going to be up about $2 On MMBtu and then freight, which will continue to be up sequentially, call it 10% or so. So those significant inflationary effects that we've been battling from a comparability standpoint over the first half of the year mitigate dramatically over second half of the year and we'll continue to mitigate in 2023. So I think just to put some numbers to what David said, I think We absolutely feel as though we're being set up for a continued strength in 2023 from a margin standpoint, Even before we take into account the effects of the WestRock operating system and all the productivity measures that David talked about. That's super helpful. I'll get to work trying to figure

Speaker 7

that all out. But one question, the freight, how big is the freight bucket approximately right now?

Speaker 4

So freight, in rough terms, about a $2,000,000,000 spend annually.

Speaker 7

Great. Thank you so much.

Speaker 6

Thanks Mark.

Operator

Our next question will come from Clive Rick Kurt with UBS, you may now go ahead.

Speaker 8

Great. Good morning, everybody. Thanks for taking the questions. I have a couple. And the first one was, I think just on the maintenance, you guys mentioned some maybe thinking about Shifting the maintenance schedule and pulling maintenance forward into 2022.

Speaker 8

I think you just answered the question, but maybe I'll ask it just for clarification. And if you're selling everything you can produce right now, why would you pull maintenance forward?

Speaker 6

So good question, Clive. We're looking at that right now. And the reason why we're looking at that We're also anticipating, as Alex said, a very strong Q1 fiscal 'twenty three, which we have a very heavy maintenance potential schedule and a very light Q4 schedule. So we're just trying Balance, what's the best thing to do so we can ensure we're servicing our customers the best way possible. We haven't made any final decisions yet, But we just wanted to put it on the radar of how we look at it because we do have such a low maintenance quarter scheduled In Q4 and a much higher one in Q1 fiscal year 2023.

Speaker 6

So we're just looking at it right now.

Speaker 4

So let me just add a little bit of color. So if you think about Q1 of this year, we had about 192,000 Tons of downtime for Q1, which led to higher absorptions, and that's why you saw the results you did In Q1. And then Q2 was about 158,000 tons of downtime. In Q3, that number drops to 57,000 tons and then it drops from there into Q4. So exactly what David mentioned, Part of the effort is to more level load the plants, so we don't have that significant Seasonality effect in the 1st part of the year.

Speaker 4

So it's really just an economic decision on how we balance delivering on demand Versus managing the downtime that we need to take.

Speaker 8

Okay. That's clear. Thanks for that. I guess and just sort of following up on the margin question, you did reduce the margin guidance at the high end of The range, there's been I think a lot of good discussion over the last couple of minutes about margin improvement into next year. And I guess if you could just give us maybe a little bit more color on what needs to happen to get back to the high end of the range.

Speaker 8

And

Operator

I don't

Speaker 6

know if

Speaker 8

you can kind of Frame what's achievable for some of these new segments. The paper segment is doing very well right now. I mean is that kind Performance achievable in the corrugated segment? Should we kind of expect corrugated margins to exceed paper margins over kind of like a more Longer term time period. Thanks very much.

Speaker 4

Yes. I'll let David pile on. I'll just help you understand a little bit about what was embedded the assumptions behind the guidance. So we did take up the midpoint of the range. We tightened it and Up the midpoint, and I think that reflects the continued strength we see in our business.

Speaker 4

I talked about some of the inflationary trends that we're seeing, And those will likely mitigate towards the back half of the year. And then obviously, we're going to have significant pricing Advantages as we get to the back half of the year. So if I talk to kind of the results in each one of the segments sort of first half to the back half On paper, we see continued strengthening on the margin standpoint as we get through the second half of the year, Largely driven by pricing and continued volume strength. The biggest upside in the model is really on the corrugated margin. As David mentioned, we exited March of Q2 at a run rate of around 17%, and we See that continuing to go north as we get to the back half of the year.

Speaker 4

Seasonally, corrugated volume tends to be stronger in the second half of the year. They'll also benefit from this lower down Time issue that we talked about and then continued flow through of pricing. They also exited. David referred to this in some of his prior comments. They In April, their daily shipment volume was the strongest we've seen so far this year.

Speaker 4

So their shipment volume has really accelerated As they've broken the back of some of these absenteeism and labor issues and also getting the benefits of the WestRock operating system. Consumer will also strengthen towards the back half of the year. And then really the only business that will likely weaken towards the back half of the year is the distribution Segment. So David mentioned or maybe I mentioned in my prepared remarks, they benefited from a very large healthcare order This quarter and so their margins will likely weaken somewhat, not significantly, but somewhat as we get to the back half of the year. And David, what would you add?

Speaker 6

The only thing I'd add, if I understood your question correctly, Gabe, is on our margins. We actually did up the midpoint of our margins. We initially provided guidance of 16.5% to 17.5% of margin range for year 'twenty two, we've tightened that now to 17% to 17.5%. So you will see both the midpoint of our margins As well as our EBITDA increase as well.

Speaker 8

Okay. Maybe there was just a little confusion because I think on the slides it says 16.5% to 17

Speaker 4

Maybe we can take it offline and we can type that out. But yes, our margin we do expect our margins to improve Through the second half of the year.

Speaker 8

Okay, thanks.

Operator

Our next question will

Speaker 6

come from I apologize on that. We'll double check on those numbers. We might have different numbers here.

Operator

Our next question will come from Mike Roxlund with Truist Securities. You may now go ahead.

Speaker 5

Hi, David, Alex, Rob, James. Congrats on the quarter. Just wanted to kick it off with the Panama City David, you mentioned shifting some containerboard grades to other mills in the network. Does that imply that you're going to be walking away from some You mentioned the word some. So I'm wondering if there's some business that may not have been profitable that you decide to walk away from?

Speaker 4

Well, I

Speaker 6

think the way I would answer that is we're going to move as much I mean, we obviously run our mills 20 fourseven, 365. But as part of our unlocking of the hidden factory, we're trying to drive where we're just driving more volume through our mills. So move and with the environment where we're in and basically a sold out environment, We will move as much volume as we can to other plants on the containerboard side through our productivity efforts to drive that volume. So it's not a question of not wanting some versus walking away from some. It's just how much we can move into Production productivity at other mills.

Speaker 5

Got it. And just one quick follow-up on corrugated. You generated a 14.7% margin this quarter. You mentioned the exit the run rate exit was about 17%. I think Dave you mentioned last quarter that margins historically in the business have been 18%.

Speaker 5

Given where you stand today, over what time do you expect to return to those types level, it sounds like you have a lot of momentum going into the back half. Did you get to that 18% level this year? And is that 18% still Target or if you look at some of your peers, they're targeting they have or generation say 20% plus, you know, some barter. So is there something higher that you're going to be reaching for Given some of the benefit from price cost and also given the WestRock operating model?

Speaker 4

Yes. So let me take a stab at it and then I'll let David Add additional color. So I mentioned in my answer to the prior question, we do anticipate significant strengthening in the back half of the year benefiting from really, Really three things, improved production volume, lower and lower downtime on the plant side, on the mill side, Improved labor issues, so improved labor productivity, pricing flow through And then continued implementation of the WestRock operating system. So I think you'll see us exit the year Much closer at a full year basis, much closer to the numbers that you're referencing as opposed to where we started the year. So that's, I guess the first point.

Speaker 4

The second point is, you'll hear from Pete during our Investor Day Next week, all of the actions that we're taking within the business to improve both the local mix, which will have a significant margin impact as well as the manufacturing efficiency of the assets, which will get us much closer To something, I think more exciting from a margin standpoint. I'm stopping shy of giving you specific segment guidance because I don't think we want to go there, but hopefully directionally you can understand some of the actions that we're taking. You can understand some of the actions that we're taking.

Speaker 5

Thank you. Good luck on the quarter.

Speaker 6

Thanks.

Operator

Our next question will come from Anthony Pettinari with Citi. You may now go ahead.

Speaker 9

Good morning. Just following up on an earlier question on pricing. One of your peers in consumer has made an effort to kind of move away from pulp and paper week published list prices and move more towards cost indices with Automatic pass throughs. Just wondering if that's something you'd consider or pursue? And then maybe just broadly as you've looked at pricing in this business coming from other Companies, are you seeing other opportunities to kind of improve pricing mechanisms or how Westrop sets contract terms?

Speaker 9

I'm just wondering if you could talk about that commercial and pricing piece?

Speaker 6

So I'll talk about it as sensitively as I can speak to it. We are relentlessly looking at how to optimize pricing And partnering with customers to provide the right mechanisms to manage pricing moving forward. On the consumer business, which you referenced, about 50% of our business is tied to contract pricing. But In the environment that we're in today, we're actively having discussions in new approaches to pricing and that dovetails into our corrugated business as well Global Paper Business. So this is something that is really important to our business moving forward, and we'll continue to Provide updates as we make changes to our approach.

Speaker 9

Okay. That's helpful. And then can you talk a little bit more about the decision to move the leverage target to 175 to 22 5, M and A has historically been a feature of the company. Should we think about that as maybe deprioritized? And maybe you can just talk about the willingness to Essentially go above the range or maybe below the range depending on conditions?

Speaker 6

Yes. So we lowered our range to 1.75 to 2.25 as we just see that is a very prudent rage in the midterm that Further reduces our risk, while properly using our leverage to drive value. It doesn't mean we're Not going to continue to pursue bolt on acquisitions that fit our strategy, that meets our leverage profile in the midterm, but it really underscores our commitment to an investment grade rating and the confidence we Our commitment to an investment grade rating and the confidence we have in the portfolio that we have today And the improvements that we can make.

Speaker 9

Okay. That's helpful. I'll turn it over.

Speaker 6

Terrific. Thank you.

Operator

Our next question will come from Phil Ng with Jefferies. You may now go ahead.

Speaker 10

Good morning. This is actually John on for Phil. I first want to say congrats on a solid quarter. And just focusing on Panama City, The $65,000,000 annual EBITDA drag, is that a net number consisting of any cost savings from that? And appreciate the return focus on your actions.

Speaker 10

But given the EBITDA leakage and $112,000,000 of cash to shutters a facility, I'm curious what type of capital would you have to spend on that to keep that facility in a good spot?

Speaker 6

That number was not net. That was a gross number on the $65,000,000 And From a capital standpoint, without getting into specifics, I would tell you it was in the 100 of 1,000,000 of dollars.

Speaker 4

Phil, maybe just to pile on it. David mentioned this in his remarks, but this is all about optimizing for ROIC and margin performance of the business. So when we looked at the investment that was required to get that mill sort of to our return It just didn't make sense. And as David mentioned, it's 645,000 tons of capacity, About 350,000 tons of linerboard capacity that we think we can capture in our remaining footprint Because of improved asset productivity and hidden factory and those sorts of things. And then the pulp capacity, Quite honestly, it's just not a strategic business for us to be in.

Speaker 4

So this was all about really signaling the first move on the portfolio Shaping actions that David's talked about a lot.

Speaker 10

Got it. I appreciate that. And

Speaker 6

Sorry, go ahead.

Operator

Sorry.

Speaker 10

And I realized that The flow through on pricing in the Paper segment, just because it's more open market and exports is tied to the spot. But How long should we think of the pricing to take to completely flow through? Maybe if you could quantify kind of where you're at in terms of the price realization In that segment, given it's pretty significant compared to the other segments and there's less of a lag. And then I apologize if I missed this, but Did you have any insurance recovery in the quarter or the benefits from the ransomware and winter outages from last year? Those are just non repeats this

Speaker 4

Dear. So maybe I'll just because the pricing thing is tricky. Obviously, the only thing we talk to on pricing are previously published Previously published pricing. And I mentioned again sequentially in Q3, we expect about $130,000,000 of flow through, which Translates to about $650,000,000 year over year, and that's published pricing. So then as it relates to each one of the segments, It's about a 3 to 6 month lag in containerboard to flow through in the contractual side of the business, and then that's about 6 to 9 months lag In the consumer business.

Speaker 4

So I think with the data that's out there externally, you can sort of do the math to figure out How that's going to translate through to the P and L? We obviously demand continues to be strong and so this is something that We evaluate on a regular basis, but obviously we're not going to talk about any forward pricing.

Speaker 10

I guess just to clarify, I was looking more on the paper segment, given that that's open market, how much quicker that's flowing through and maybe quickly we can expect the realization in that particular segment?

Speaker 6

Yes, John, it's a good question. And You hit you got the most important part is we get pricing first in paper, typically. However, We have, as you would imagine, some very large global contracts with customers where That immediate pricing doesn't always take shape. So it's a little bit of a balance where a majority of our Business, we get that pricing right away, but we do have large strategic customers where contractually we work through the contract, so that would continue to flow through. So you will see a little bit more flow through on pricing, but at a much smaller level than you would see on consumer and corrugated.

Speaker 6

And then on your other question on the ransomware business interruption insurance, we did receive $5,000,000 in insurance money in the

Speaker 10

Great. Thank you very much.

Speaker 6

Thank you.

Operator

Our next question will come from Kyle White with Deutsche Bank. You may now go ahead.

Speaker 11

Hey, good morning. Thanks for taking the question. I just wanted to focus on some of the costs and what's embedded in the guidance. On transportation, we've started to see some of the truck spot rates decline even when you factor in surcharge from diesel. I guess, are you starting to see any benefits of this starting to flow through to your contract rigs?

Speaker 11

Do you expect any moderation in the second half?

Speaker 4

Yes. So I think I mentioned, we do expect freight to continue at inflated rates year over year, so call In the mid teens year over year, but we do expect that to mitigate as we get to the back half of the year. And then for all the reasons that you're talking about, there's improved driver availability, improved lanes, better mode, all of those sorts of things.

Speaker 11

Got it. I wasn't sure if the mitigate was just a year over year comp thing or if it was sequentially sequentially No,

Speaker 4

Sequentially, sorry, it wasn't clear. So I'm talking sequentially, not year over year.

Speaker 11

Got it. No, that's probably my fault. And then on natgas, I appreciate the sensitivity that you guys have in the appendix, but curious about kind of the overall purchasing strategy. Do you have any forward contracts that protect you from near term volatility going into the next quarter? And what does your outlook assume for natgas prices going forward?

Speaker 4

Yes. So obviously, this is a very interesting time in the natural gas markets. And as you might imagine, we're Actively evaluating what our forward buying strategy should be. Historically, we've not participated in large So either derivatives or forward buys and so been more exposed to spot. Our outlook for the back half of the year does Anticipate roughly $2 an MMBtu inflation from where we were exiting the quarter.

Speaker 4

So really almost 100% up Year over year. So we are, I think being appropriately aware of the market conditions, If I can say it that way. Just to help you with the sensitivity, so we're on Q4, we're anticipating ending and Call it the $750 zip code. I think yesterday we were north of $8 an MMBtu. To help you model it, dollars 0.25 Per MMBtu is worth about $23,000,000 of EBITDA.

Speaker 4

So you can sort of, I think, do your own math on how that will translate through to the P and L.

Speaker 11

Got it. Thank you. I'll hand it over.

Speaker 6

Thank you.

Operator

Our next question will come from Mark Wilde with BMO. You may now go ahead.

Speaker 12

Good morning, David. Good morning, Alex.

Speaker 4

Good morning, Mark. Good

Speaker 12

morning. I wonder just coming back to Panama Citi, one more time, you said that prospective capital items were in the 100 of 1,000,000. I'm just curious, over the next 3 to 5 years. Are there other mills where you expect to be kind of facing kind of similar decisions? I'm not asking you to predict whether there are going to be other closures or anything, but just whether there are other mills where you're going to have to take a good hard look At these very lumpy capital items?

Speaker 6

Yes, Mark. So the best way I could answer that is We look very deep at all of our assets as part of our strategic process. And Panama City was part of an ongoing Deliberate and methodical transformation process to improve our return on invested capital. We go through this With every one of our assets and we take great sensitivity to it. We have employees that have been 30, 35 year Employees of the WestRock family.

Speaker 6

So we're very sensitive to any commentary on future actions other than to say our preference is always to invest And the assets we have to deliver the returns and improve the asset base and where those assets require an investment That don't generate the returns that are needed for the company is where we then look at taking strategic action.

Speaker 12

Okay. That's fair enough. Then I wonder just toggling over to the reduction in the leverage target that 1.75 to 2.25 puts you well below other peers, particularly other packaging companies who are Typically up in the 3x range. Any thoughts

Speaker 5

on that? Is it just

Speaker 12

a reflection of a little more cyclicality In the paper packaging business or how did you think about that?

Speaker 4

Yes. So Mark, I'll David took a stab at it, so I'll take a stab at it. Look, this is a, I think, a signaling of a couple of things. The first There's our extreme level of confidence in the cash flow generation power of the business and in the earnings power. And so Obviously, the choice when we have that strong sort of value creation algorithm is the first priority is obviously investing in the business to Higher ROIC projects and growth projects.

Speaker 4

And then we start thinking about how we want to return capital to shareholders through Sustainable and growing dividend and opportunistic share buybacks and then obviously managing the balance sheet. So I think that's probably an important headline. The second important headline is the conviction that David mentioned to really maintain a very prudent balance sheet. And it really doesn't have anything to do with a view on where we are in the cycle as much as just signaling our conviction to maintain a prudent balance sheet and Not pursue large scale transformational M and A. And we think in the 1.75 to 2.25 range That we can continue to pursue strategic tuck in bolt on acquisitions, which we'll describe in more depth next week.

Speaker 4

But it gives us sufficient flexibility, while optimizing our cost of capital. And obviously, if we get below the 1.75 times, then we have Choices to make around opportunistic share repurchases or dividend or whatnot.

Speaker 12

Okay. All right. That's fine. And just one other real quick one. Is it possible, Alex, to get some sense, like down at the converting plant level, about what how much you're having to move labor rates Just to both attract and retain people at this point?

Speaker 12

I know mill level wages tend to be much higher, so I assume you have less of an issue there, but Like down at a corrugated plant or a carton, just any ballpark sense?

Speaker 4

I can give you on an aggregate basis, It's actually not as material as you might think. So if you think year over year aggregate labor costs are up, Call it 3% on a full year basis year over year. That's what's embedded in the assumptions that we've provided. I think It varies as you get into specific geographies and specific mills. And so what we're trying to do and Pete and Vicki And the team is working very hard on making sure we're competitive to unique local market conditions, both in terms of Wage rates over time, those sorts of things.

Speaker 4

When we talk about labor issues, actually what's the bigger issue is not the wage rate as much as it is just How hard the people are working because the demand environment has been so strong and we've been pushing Overtime people just haven't wanted to work those hours. And so we've been really trying to Add labor to address the overtime issues and as you bring new people on board, you obviously have to train them and you have productivity issues. So The labor issues that we've talked to are really more related to attrition, overtime related attrition as opposed to paying below market Wages, but 3% year over year would be, I think, in line with historical rates.

Speaker 12

And that would be across the company?

Speaker 4

Correct.

Speaker 12

Okay. Very good. I'll turn it over.

Speaker 6

Thanks, Mark.

Operator

Our next question will come from Adam Josephson with KeyBanc. You may now go ahead.

Speaker 13

David, Alex, good morning. Thanks very much for taking my questions. Alex, one more or David for that matter, just one more on the leverage target that Mark was asking about. And had there not had the previous management not had a leverage target out there, might you have just Is there a particular reason for it? In other words, why not just let the chips fall where they may, if your stock is particularly undervalued or there's a really attractive deal out there, Then you can proceed accordingly, but why the need for any range?

Speaker 4

So, Adam, I'm new to the company, Well, I'll take it as the new CFO and then David has been here a little longer and he can add his sort of points of view. I think given where the company sits And some of what we've observed in the market, it's very important for us to be As we possibly can be and show as much conviction behind our strategy quantitatively as we possibly can. And I think this is one way For us to show absolute conviction to the desire to focus internally on driving the WestRock operating system, improving margins, improving ROIC And not pursuing a large scale transformational deal that forces us to lever up. I don't know how to Say it more simplistically than that.

Speaker 6

No, I think the only other thing that's coming in. No, no, I think your point is Valid. I'm sorry, I didn't mean to speak over you if you

Speaker 13

want to. Okay.

Speaker 6

No, no, no. I was just

Speaker 12

going to say

Speaker 6

I'm going to let you finish, Adam, and then I'll go.

Speaker 5

Well, I was just going to I

Speaker 13

mean, this transformational obviously, there have been some transformational deals in the company's history that didn't go as Management team's experience have anything to do with it?

Speaker 6

Well, I think I would answer it 2 ways. The first one is the internal opportunities we have are so significant To the point you just made that we made all of these transformational acquisitions and we haven't seen the value out of them. So let's get the value out of them. And the target range we're saying is not for perpetuity. It's just saying in the short term, We are going to relentlessly focus on extracting the tremendous and unlocked value of these assets that we have acquired.

Speaker 6

And so there's a little bit of messaging on, okay, over the next Short term period, we are going to get internal right. You are going to see the value from these acquisitions we've made. And if these incredible opportunities come up that fit within our strategic priorities, we'll have that discussion. But to your I think you've kind of answered the point Adam is, I think we're seeing as, hey, A strategy of let's do a lot of M and A, lever the company, and focus on free cash flow, Where we're now pivoting to, we're going to get return on invested capital, we're going to drive margin expansion, we're going to take out some SG and A and we're going to drive productivity. And so I think that's kind of part of the messaging here.

Speaker 13

I appreciate that. And just one more one last one for me, if you don't mind. You asked about box demand and what you were seeing in April. And I presume that those questions were getting asked because there are numerous economic indicators that are Pointing in, shall we say, the wrong direction. And historically, at least, box demand has been very economically sensitive, boxboard less so.

Speaker 13

We saw that in 2008, 2009. How would you frame the economic sensitivity of these two businesses, just from your perspective?

Speaker 6

Well, this is what the beauty of our model is, is our incredible We serve more end markets, more geographical touches Across more substrates than any other producer. And so what that allows us to do Is if there is 1 or 2 market dynamics that are softening certain segments, We can pivot and flex to grow in those other segments. And that's why we're so confident in our future With the reduced cyclicality that we're able to provide with our model and so we're very confident.

Speaker 13

Thanks so much, David. Look forward to seeing you next week.

Speaker 6

Appreciate it. Thanks, Adam. Look forward to seeing you.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Rob Quartaro for any closing remarks.

Speaker 8

Great. Thank you everybody for joining our call today. As a reminder, James and I are available for any other questions you have. And we look forward to updating everybody next week with more details on our long term strategy and goals at our Investor Day. So thank you very much.

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Earnings Conference Call
WestRock Q2 2022
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