International Paper Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 27, 2022

There are 13 speakers on the call.

Operator

Good morning and thank you for standing by. Welcome to today's International Paper's 2nd Quarter 2022 Earnings Call. All lines have been placed on mute to prevent background noise. After the speakers' remarks, you will have an opportunity to ask questions. On your telephone keypad.

Operator

As a reminder, this conference is being recorded. I'd now like to turn today's conference over to Mark Nelson, Vice President, Investor Relations. Sir, the floor is yours.

Speaker 1

Thank you, Paul. Good morning, and

Speaker 2

thank you for joining International Paper's 2nd quarter 2022 earnings call. Our speakers this morning are Mark Sutton, Chairman and Chief Executive Officer and Tim Nichols, Senior Vice President and Chief Financial Officer. There is important information at the beginning of our presentation on Slide 2, including certain legal disclaimers. For example, during this call, we will make forward looking statements that are subject to risks and uncertainties. We will also present certain non

Speaker 3

on U. S. GAAP Financial

Speaker 2

Information and a reconciliation of those figures to U. S. GAAP Financial Measures

Speaker 4

is available on our website.

Speaker 2

Our website also contains copies of the 2nd quarter earnings press release and today's presentation slides. I will now turn the call over to Mark Sutton.

Speaker 5

Thank you, Mark, and good morning, everyone. We will begin our discussion on Slide 3. In the 2nd quarter, International Paper strong revenue growth and earnings growth on both a year over year and sequential basis, all while expanding our margins. In addition, our 2nd quarter earnings were better than our prior outlook, driven by strong price realization, solid operating performance and cost benefits. All of this help us overcome significantly higher input costs, especially for Energy, Chemicals and Distribution.

Speaker 5

Our mills and converting system performed very well as we manage through continued logistics constraints, which negatively impacted our operating costs. We successfully executed our 2nd highest maintenance quarter of the year and have completed about 65% of our planned maintenance in the first half of the year. Demand for our products was impacted by a shift in consumer spending from goods to services in the quarter, while the retail channel managed through elevated inventories. In addition, our businesses continue to focus on serving our customers' needs while navigating through a challenging supply chain and labor environment. We made good progress on our building a better IP Initiatives.

Speaker 5

We achieved $65,000,000 of earnings in the quarter for a total of $105,000,000 through the first half of the year. Given our strong momentum, we expect to achieve the high end of our full year target of $200,000,000 to 225,000,000

Speaker 6

We are

Speaker 5

excited by the opportunities we have identified to significantly lower our cost structure and accelerate profitable growth. On capital allocation, we returned $565,000,000 to share owners in the 2nd quarter, including 3.90 $5,000,000 of share repurchases. As a result, we've returned more than $1,100,000,000 of cash to share owners so far this year. This highlights the choices that our strong balance sheet and cash generation provide us. On our last call, I mentioned that we were Pursuing strategic options for our equity investment in the Hillham Group, which includes possibly selling our 50% stake.

Speaker 5

We have engaged advisors and are actively working with interested parties. We've made good progress during the Q2 and have identified serious options that we believe could be attractive. As I mentioned before, the complexity of the situation and our JV structure impacts the pace of reaching a resolution. We will provide another update when there is more information to share. Turning to the 2nd quarter results on Slide 4.

Speaker 5

Revenue increased by 13% year over year, driven by strong price realization across our 2 business segments. Operation earnings per share improved by just over 50% versus last year. And margins improved in the 2nd quarter as strong price realization more than offset higher contribution input cost, and we delivered additional benefits from our Building of Better IP initiatives. Free cash flow was lower in the quarter due to higher working capital use as we grew revenues and replenished inventories coming out of our highest maintenance outage season. In addition, both prior periods included a dividend from our equity ownership in Ilim.

Speaker 5

Looking to the rest of the year, we expect Further margin expansion as continued realization of prior price increases outpaces higher input costs. In addition, we stepped down from our highest maintenance outage quarters of the year and also expect additional earnings growth from our Building a Better IP initiatives. As a result, I'm confident performance and outlook. Tim?

Speaker 6

Thank you, Mark. Good morning, everyone. I'm on Slide 5, which shows our sequential earnings bridge. As Mark mentioned, we generated strong earnings growth in the Q2 relative to the prior quarter and prior year, driven by strong price realization and execution of our Building a Better IP initiatives. 2nd quarter operating earnings per share were $1.24 as compared to $0.76 in the Q1.

Speaker 6

Price and mix improved by about 206,000,000 or $0.40 per share with strong price realization in both business segments and across all channels. Volume was relatively flat sequentially in our Industrial Packaging segment and Global Cellulose Fibers, fluff pulp Shipments continue to be constrained by ongoing vessel delays. Operations and cost improved sequentially as our mills and converting system Formed Well. In the Q2, we received $16,000,000 of insurance recovery related to Prattville. In addition, one time items for things like lower employee benefits costs, medical claims and workers' comp contributed favorably to operations and cost.

Speaker 6

These one time items added about $80,000,000 or 0 point 16 dollars per share, which will not repeat in the Q3. We successfully completed our 2nd highest maintenance outage quarter of the year and 65% of our Annual Meetings Program through the first half of the year. Input costs were about $100,000,000 or 0.20 per share in the 2nd quarter, driven by higher energy chemicals and distribution costs, in large part because of higher diesel fuel prices. On Slide 33 of the appendix, we provide details on our consumption by key inputs, including natural which was also a significant cost headwind in the quarter. Corporate and other items included benefits from lower tax expense and a lower share count.

Speaker 6

Lastly, equity earnings were stable versus the prior quarter. Turning to the segments and starting with Industrial Packaging on Slide 6. Looking at the 2nd quarter performance, We delivered meaningful revenue growth and margin expansion. Price and mix was strong and better than our expectations due to faster than expected implementation of our March price increase and higher export prices. Our volume was flat sequentially and below last year's strong comp.

Speaker 6

As Mark mentioned earlier, we saw a shift in consumer spending from goods to services and the retail channel managed through elevated inventories, which then impacted box demand across segments like e commerce and Shipping and Distribution Durables and Other Non Durables. We firmly believe these segments will continue to grow over time and that IP is well positioned to grow with them. In addition, the tight labor environment continues to constrain our box plant system. We're experiencing this especially in regions where we are consistently operating our plants on weekends to serve elevated demand from segments like e Commerce and Shipping and Distribution that have grown significantly during the last couple of years. Going forward, we will continue to focus on further optimizing our system by improving staffing levels and investing across the system to serve the growing demand of our customers.

Speaker 6

Operations and cost improved sequentially. Our mills and box system ran very well and we successfully executed our 2nd highest maintenance outage of the year. The business also benefited from additional insurance recovery of $16,000,000 related to Prattville and the one time items I mentioned earlier by approximately $60,000,000 Operating costs remain elevated due to ongoing logistics constraints. However, we are in a much better position to navigate due to higher costs for energy, chemicals and distribution. We expect these elevated costs to persist in the 3rd quarter.

Speaker 6

These cost headwinds are even more significant for our Packaging business in Europe, where input costs in the Q2 were $45,000,000 higher than the Q2 of last year. About 70% of that headwind was from higher energy costs where natural gas prices have averaged about 5x normal historical levels. Turning to Slide 7 and staying with North American Industrial Packaging. We are focused on continuing to grow earnings by restoring margins to historical levels in the low 20 percent range. We've made solid progress in the quarter and delivered a 19% margin, up from just over 15% in the first quarter despite higher than expected input cost.

Speaker 6

We're still confident we can achieve our target. However, the additional Our mills and box plants operated very well. Containerboard inventories across our system are back to sufficient levels, so we are better positioned to proactively manage through the ongoing supply chain constraints. As I said earlier, we will deploy an investment strategy that further enhances our capabilities and footprint to grow with our customers while generating attractive financial returns on these investments. This is a key part of building a better IP.

Speaker 6

And an example of this is the Greenfield box plant that we are building in Southeast Pennsylvania, which is expected to start up early next year. In addition, our Building a Better IP initiatives are also focused on structurally reducing cost and deploying commercial strategies to improve mix and margins. Moving on to Global Cellulose Fibers on Slide 8. Our confidence reflects the essential role of absorbent hygiene products and meeting customer needs. Continues to indicate that flat pulp inventories are near historic lows.

Speaker 6

Supply chains continue to remain stretched, driven by ongoing port congestion and vessel delays, and we expect these challenging conditions to continue for the foreseeable future. Taking a look at the 2nd quarter performance, price and mix improved by $53,000,000 due to successful execution of previously announced price increases with solid momentum as we enter the 3rd quarter. Volume in the quarter was stable. I would note that backlogs remain high and are about double our normalized levels due to the logistics challenges. Our mills continue to run well.

Speaker 6

Ops and costs were better in the quarter as the business benefited from onetime items I mentioned earlier by approximately $20,000,000 Lastly, input costs increased by $22,000,000 sequentially. About 65% of the additional cost was the result of higher energy prices with the remainder coming from higher chemicals and trade. Turning to Slide 9. I want to reaffirm that Global Cellulose Fibers remains well positioned to deliver cost of capital returns in the 3rd and 4th quarters of this year. As I said earlier, we have a favorable supply outlook for fluff pulp with price realization from prior increases accelerating as we move through the year.

Speaker 6

I would also note that as part of building of Ever IP, we are focused on driving structural margin improvement by ensuring we get paid for the value we provide to our customers and aligning with the most attractive regions and segments to deliver profitable growth. We are also making solid progress and our FlexPulp contract negotiations, which we anticipate will provide additional commercial benefits as we move into 2023. Turning to Slide 10, I'd like to update you on the building of our IP set of initiatives. We're making solid progress and delivered $65,000,000 earnings in the 2nd quarter for a total of $105,000,000 for the first half of the year. Given the strong momentum, we're on track to achieve the high end of our full year target.

Speaker 6

About half the benefits to date are from our lean effectiveness initiative. By streamlining our corporate and staff functions to realign with our more simplified portfolio, We have already offset 100 percent of the dis synergies from the printing paper spend and we have line of sight to additional savings from initiatives targeting lower overhead spending and further optimization. We are designing the organization to support a packaging focused company with a more focused footprint. We believe our process optimization initiatives have the potential to significantly reduce costs across our operations by leveraging advanced technology and data analytics. Over the past year, dedicated teams have been working with outside experts to identify opportunities and develop new tools and capabilities to increase efficiency and reduce costs in areas such as maintenance and reliability, Distribution and Logistics and Sourcing.

Speaker 6

We are beginning to scale these capabilities across our system, which we believe will yield significant savings as we go through 2023. And finally, strategy acceleration is about delivering profitable growth through commercial and investment excellence. As I mentioned earlier, we're focused on profitably growing our North American Packaging business by improving margins and investing for organic growth. We are further optimizing our European operations by improving performance and increasing integration of our Madrid Mill and Box System. And we're well on our way to achieve cost of capital returns in our global cellular Fibers business by realizing more value for absorbent pulp.

Speaker 6

In summary, building a better IP is about driving structural margin improvement and profitable growth. Turning to Slide 11, outlook. I'll start with Industrial Packaging. We expect price and mix to improve by $40,000,000 on realization of prior increases. Volume is expected to increase by $10,000,000 with 1 more day sequentially and stable demand.

Speaker 6

Operating costs are expected to decrease earnings by $75,000,000 largely due to the non repeat of the one time favorable items I mentioned earlier. Maintenance outage expense is expected to decrease by $41,000,000 And lastly, input costs are expected to increase by $30,000,000 In global sale of fibers, we expect price and mix to improve by $60,000,000 on the realization of prior increases. As a reminder, price realization in this segment has a 2 to 3 quarter lag. We're running on the longer end of that range right now due to the ongoing vessel delays. Volume is expected to remain stable sequentially.

Speaker 6

Operations and costs are expected to decrease earnings by $30,000,000 due to non repeat of favorable one time items in the 2nd quarter and timing of spending. Maintenance outage expense is expected to decrease by 24 and lastly, input costs were expected to increase by $5,000,000 Moving to our full year outlook on Slide 12. We remain confident in our full year EBITDA outlook of $3,100,000,000 to $3,400,000,000 and our free cash flow target of $1,300,000,000 to $1,500,000,000 We generated strong revenue growth and margin expansion in the 2nd quarter, exceeding our earnings outlook for the quarter, which provides solid momentum as we enter the second half of the year. We expect demand for corrugated packaging to remain stable. And Cellulose Fibers.

Speaker 6

We see a continued favorable supply demand backdrop for pulp. We continue to realize benefits across the portfolio from the implementation of prior price increases, while distribution and input costs are expected to stabilize later this year at elevated levels. Earnings. Regarding capital expenditures, we have lowered our full year estimate by $100,000,000 due to extended lead times on equipment purchases. Despite these equipment delays, we are committed to investing in our business to support strategic growth opportunities and to structurally reduce our costs.

Speaker 6

Let me turn to Slide 13 and take a moment to update you on our capital allocation actions in the 2nd quarter. Starting with the balance sheet. As I said last quarter, we're very pleased with the progress we've made to strengthen our balance sheet. As a reminder, we reduced debt by $2,500,000,000 in 2021 and more than $4,000,000,000 over the past 2 years. With these actions, our 2021 year end leverage was 2.3 times on a Moody's basis, which is below our target range of 2.5x to 2.8x.

Speaker 6

And looking ahead, we have limited medium term maturities with about $900,000,000 due over the next 5 years. Returning cash to shareholders is a meaningful quarter for our capital allocation framework. In the second quarter, we returned $565,000,000 shareowners including $395,000,000 through share repurchases which represents 8,700,000 shares or about 2.3 percent of shares outstanding. As a result, we've returned more than $1,100,000,000 of cash to share owners so far this year. At the end of the second quarter, we had $2,100,000,000 remaining in share repurchase authorization.

Speaker 6

Investment excellence is essential to growing earnings and cash. As I mentioned, we are targeting CapEx of $1,000,000,000 which includes funding for strategic projects in our packaging business to build out capabilities and capacity in our box system to drive profitable We also plan to increase funding for cost reduction projects with expected returns in excess of 25%. We will continue to be disciplined and selective when assessing M and A opportunities that may supplement our goal of accelerating You can expect M and A to focus primarily on bolt on opportunities in our packaging business in North America and Europe. Any potential opportunity we pursue must be compelling long term value for our shareholders. Turning to Slide 14, I want to highlight the strength and resiliency International Paper going forward.

Speaker 6

With this as a backdrop, I'm confident IP will navigate any economic environment from a position of strength. We have a very strong balance sheet, which we will preserve because we believe it's core to our capital allocation framework. Our strong balance sheet ensures financial stability and optionality in softer economic environments and is the foundation to create significant value throughout the economic cycle. As a result, we can continue to return cash to shareholders in a meaningful way through a sustainable and competitive dividend and through opportunistic share repurchases. We can also proactively invest in our business throughout the cycle to create significant value by reducing cost and by developing the capabilities we need to meet the growing demand for our customers.

Speaker 6

Our large system of mills and box plants provides us with added advantage of flexibility and optionality. We've demonstrated our ability to optimize our cost structure throughout different demand environments by making more of our costs less fixed and more variable. For example, we can increase utilization across our system During strong demand environments and if demand moderates, we can shift production to our lowest cost operations and shed high marginal cost across the system based on regional costs for fiber, energy and supply chain. We also have levers to manage working capital needs to align with the demand signal. One last point.

Speaker 6

As I talked about our confidence in delivering our Building a Better IP initiatives, we have line of sight to these opportunities and believe they are largely within our control and not dependent on economic tailwinds. In summary, the strength and resiliency of IP enables us to consistently create significant value for our shareowners Q1 results. And with that, I'll turn it back over to Mark.

Speaker 5

Tim, thanks for covering the details on the business outlook and our capital allocation progress. This is a really exciting time for International Paper and I continue to be proud of our team and the work that they do every day in every area of the company. Sitting here midway through the year, I'm confident in our earnings outlook for 2022 and in our ability to deliver strong earnings growth this year. I'm also very pleased with our progress and momentum in building a better IP, and I'm confident our team is focused on taking our performance to the next level. As Tim pointed out in his remarks earlier, these initiatives are largely within our control and will create structural earnings improvement for IT over the next couple of years.

Speaker 5

And finally, while I'm mindful of the uncertainty surrounding the macro environment, I'm very certain about the resiliency of International Paper. During the past few years, we have significantly enhanced our financial strength and flexibility. This strong foundation makes IT well positioned for success throughout a wide spectrum of economic environments. With that, operator, we're ready to take questions.

Operator

Thank you. Thank you. We will pause a moment to compile the Q and A roster. And our first question will come from Seaport Research Partner in the line of Mark Weintraub. Please go ahead.

Speaker 7

Thank you. Good morning. Question on what you're seeing in the targeted box business. I think you mentioned that retail, they were working through elevated inventories customers. Where do you think you might be in that process?

Speaker 7

Also, any more color on that comment you made, goods Services. And relatedly, you talked about flattish volumes in the Q3. Was that a sequential relative to second quarter? Was that a year over year reference? Because I think your Q2 thought shipments were somewhat lower than your Q3 from a year ago.

Speaker 6

Yes. Hey, Mark, it's Tim. Yes, it is sequential. It could be down a little bit year over year. So I mean, it's a good question about time to work off excess inventories and what we're seeing.

Speaker 6

I guess our belief is hearing from customers that think it's going to take a little bit more time. There have been some shifts, more travel, less purchase of goods that we've noticed. Also, just unit volume through retail, as people adjust given the high inflation All right. So but it seems like that was a fairly quick shift as people are making day to day decisions. And so our view is we're in the Q3 is that it's going to be roughly flat from 2nd to 3rd on volume.

Speaker 7

Okay. And obviously, you did great on price and mix. Just one clarification. When you had been giving us kind of expectations on cost and operations, Had that been including the one time $80,000,000 in total? Or how much of that might have been in your guidance?

Speaker 6

If we know about it, we included, sometimes things come through just better than expected and it's timing. I mean, Some of it was probably expected not to hit until the Q3. And so it happened in the second. It's not going to happen again. So When you think about the one times, you think about 2 and 3Q together, I think we're about where we thought we were going to be.

Speaker 7

Okay. So it was a mix. Some of it you're expecting, but not all of it. Is that fair?

Speaker 6

That's right.

Speaker 7

Great. Thank you.

Operator

Thank you. Next, we go to Wells Fargo Securities in the line of Gabe Hajde. Please go ahead.

Speaker 3

Thank you

Speaker 8

very much, Tim. Good morning. Thanks for taking the question. One on CapEx, I think it came down about $100,000,000 from what you were previously expecting. And I'm curious just, I mean, kind of given inflation that we're seeing, I would expect just maybe a little bit of a natural tendency upwards.

Speaker 8

Is this a reflection of anything that you're seeing in the business in terms of willingness to put capital to work, being conservative or are there projects that you just kind of push to the right maybe to 2023 until you get better visibility into the business?

Speaker 5

That's a great question, David. This is Mark. It's purely an ability to actually spend the money. A fair amount of our capital is investments in our packaging business, which is new plants new equipment. And what we're hearing from our vendors is the backlog for some of that equipment pushed some of our spending We do see escalation, but and if we could do everything we wanted to do in the calendar year of 2022, we'd probably be looking at raising our capital.

Speaker 5

But it's really just an ability to get the items we need purchased. It's less about installation labor. It's more about new OEM Which is a big part of our non maintenance capital and most all of it is in the box business. So we'd spend it if we could is a simple way No change in strategy, no change in our focus, just the ability to get all of that done and Account Forward in the calendar year 2022.

Speaker 8

All right. Thank you. And then, I guess in terms of end markets within corrugated. You mentioned retail is 1 and I guess e comm is sort of moderating. Are you seeing anything on the export markets?

Speaker 8

I mean, one of the things that we're kind of keeping an eye out for is obviously to the extent they're rolling capacity outages over in Europe because of energy availability and or costs. Maybe the export lever kind of ticks up for you guys. Anything there?

Speaker 6

Yes. So on export, I'll talk pulp first and then containerboard. On pulp, as I mentioned in the comments, supply demand fundamentals We try to look through by region as much we can to gauge inventories. Of course, we talk to customers and what they're telling us and inventory levels look like they're at historic lows at the moment. So We expect underlying demand to continue to be strong globally for fluff pulp and Certainly, supply chain is contributing to that because the vessel delays are really not much better than they have been in the past several quarters.

Speaker 6

On containerboard, I think you're referencing Europe. We are going now in the Q3 into a seasonally slower period of time in Europe, but We saw solid demand and we saw price increase through the second quarter. It may moderate a little bit just in a

Operator

Thank you. And next we go to Bank of America and the line of George Staphos. Please go ahead.

Speaker 9

Hi, everyone. Good morning. Thanks for all the details and thanks for taking my question guys. I guess the first question I had, obviously, IP has been spending more understandably on the box network and additional converting. You've had mill projects like Riverdale.

Speaker 9

Can you remind us on where in your capital budget, you think you'll need to spend just on fiber lines and Recovery Boilers. How do you see your fleet there? Will there be any incremental investment that's required there or not? And Kind of the related, if you will, corrugated question. You were answering Dave's question earlier on export.

Speaker 9

How do you see some of your other domestic markets? In particular, what are you hearing right now from your ag and protein customers? What you see in 2Q, what's the outlook for next year, given what have been some of the drought conditions that have been discussed? And I had one follow on.

Speaker 6

So, George, on the capital spending, we take a longer term view on capital. I think what you're talking about would be what we characterize as maintenance capital that there's nothing that we're looking at in terms of major back end of mill types of expansions or additions. So We've probably been a little bit lower in the past couple of years on maintenance. It's up this year, but it kind of normalizes in that Roughly $500,000,000 a year range. So and again, on maintenance, we take And so it does ebb and flow just because of timing of when equipment need to be taken down and maintain some of that's periodic, some of it's on an annual basis, but I wouldn't call out anything exceptional around the capital part.

Speaker 6

And then what was the second part of your question? I'm sorry.

Speaker 9

Just box markets Domestically and in particular where I'm probing is protein markets. What are you hearing from customers now and into 2023 Given

Speaker 4

drought conditions and what that

Speaker 9

could mean for amongst other things cattle raising and perception as a result.

Speaker 6

Yes. I think on protein, we expect poultry to be strong, most popular form of protein and given Cost increases across all the protein. Maybe there's a shift from beef and pork to poultry. So we think generally protein Should be okay. Poultry should probably be the beneficiary for the foreseeable future.

Speaker 5

I think the drought Comment, George, is primarily a beef issue because they'll have to process

Speaker 1

some of

Speaker 5

the cattle early. But It doesn't affect the availability as much on things like poultry. It affects, obviously, the price of feed and the cost of those products. It's the beef issue where they will have to pull forward the slaughter a certain amount of the herd earlier than they would like.

Speaker 9

Thanks Mark. My last one and I'll turn it over. So overall, I realize you don't want to make this To formal guidance or an algebra class, our takeaway from your discussion earlier on the outlook should be that if we added our numbers right, we're Looking at sort of flattish sequential performance in industrial and kind of a $50,000,000 ish increase and pulp. Would that be correct? And when do you ultimately see on the pulp side the supply chains normalizing?

Speaker 9

Is that something 4th quarter. I realize it's ultimately a who knows, but when are your contacts saying that that should normalize? So thanks for that and good luck in the quarter.

Speaker 6

Yes. I'd say you're in the ballpark in the way you're thinking about it, George, on supply chains. I think you had that right too. Who knows? One port seems to improve and another port Seems to deteriorate and we've seen it both on the East Coast where it's Very important for the soft pulp business.

Speaker 6

The West Coast ports have knock on effects for us sometimes. But Yes,

Speaker 5

it seems to be just moving port to port. George, Tim is right. I mean, we look at it very, very closely

Speaker 3

because of the export posture of our cellulose fibers.

Speaker 5

We honestly, We honestly can't see any market improvement in the calendar year 'twenty So we're probably looking into 'twenty three when maybe there's some balanced returns to the vessel shipping and port throughput. But we maybe we're wrong, but we definitely don't see anything on the horizon as far as we can really look.

Speaker 9

Thank you, Mark. Thank you, Tim.

Operator

Thank you. And next we go to the line of Mark Wilde of Bank of Montreal. Please go ahead.

Speaker 1

Thanks. Good morning, Mark. Good morning, Tim.

Speaker 10

Good morning.

Speaker 1

I want to just turn to Cellular Specialties for a minute and Try and unpack getting the cost of capital there because it sounds like first of all, if you're outed essentially kind of 3 quarter price lag. What we saw in the Q2 is probably more indicative of what we would have seen last year in the Q3 in terms of kind of net price. And I guess I'd like to have you just unpack for us that lags and pricing and then the things you're doing to try to improve the business because if you just look at the pulp prices that are posted right now. They're at the high end of the historic range. So I'm just trying to get some comfort if and when pulp rolls over that you're actually going to be able to maintain cost of capital returns?

Speaker 5

Yes. I think on the unpacking part of your question, the 2 to 3 quarter lag is an all in. Part of that is obviously spot by definition goes up immediately on the placement of new orders. And then there's different levels of contracts with customers. And when you put it all together, announced price of X is actually equal to X 2 to 3 quarters later.

Speaker 5

So we've got our business part in contract, part in spot, and that's why you see a unique realization schedule for IP. That may not look like anybody else's. And so that's also what provides that dynamic of The contract piece also provides the resilience on any kind of turnover in pricing. Just like it Slowed it on the way up, it slows it on the way down. So I think when we have the second half in the books, there'll be 2 quarters in a row at above cost of capital performance or right at cost of capital performance.

Speaker 5

We've made some structural changes in our go to market strategy Regionally on the spot side and just contractually on the large customer contract side, which will still be in effect in a different pulp market. So we think through a cycle, the purpose of what work we've been doing is to have this business perform at the cost of capital through a normal business cycle. Tim said it in kind of straight language, we are working and have made tremendous progress. We are working to get aid for the value of the absorbent pulp that it provides in the end products. And that hasn't always been the case.

Speaker 1

Okay. All right. For my follow on, Mark, I would just like to follow-up on your comments around bolt on M and A in Industrial Packaging in North America and Europe. I'm just curious, Would bolt on rule out sort of a large deal like you were looking at in Europe 3 or 4 years ago?

Speaker 5

Yes. That's not that wouldn't be what we would consider bolt on. Bolt on, think about this think about it this way, Mark. In Europe, we have a smaller business, dollars 1,500,000,000 and Revenue Roughly. And we've done some single and multiple plant acquisitions to build an integrated network around our new containerboard mill in Madrid.

Speaker 5

So natural synergy to an existing part of our business. But we did enter a new market. We entered The Portugal market, we didn't have anything there before, but it's integrated to the Madrid mill. So that would be bolt on. And in the U.

Speaker 5

S, a much bigger business. So It could be more synergistic with a containerboard and box system, but not transformational. I think the what we've been saying for a while As this is the first time IT has been in a position with a balance sheet like we have with a much more streamlined portfolio and 2 businesses that have a right to win in their respective markets. And we're going to run with that strategy now. There's no need for transformational activity.

Speaker 5

We went through a lot of that. We undid some of it. And we've got a company we really like right now. And now it's about getting into its full potential.

Speaker 7

Okay. And is

Speaker 1

there any way in North America, Mark, just to help us a little bit in thinking about sort of regulatory barriers on your growth in the containerboard business.

Speaker 5

It's hard to say. A lot of time has passed since the last time we made any meaningful move, but there's no real reason we can't grow our Converting and Box Business. And you've seen how we've chosen everyone has seen how we've chosen to grow our containerboard to match that box. And that's been mostly through organic activity. And so I don't know the answer to your question because we haven't tested it.

Speaker 5

It was an issue back in 2012 where we did get pushback on how much we were trying to acquire, but that was a long time ago. Our focus right now, honestly, is we have enough containerboard for the foreseeable future. We did the Riverdale mill. We've got more opportunity in our currently to make more containerboard. It's really about making sure we have the box business configured both with assets and with people and we're short on both of those right now to be able to actually grow at minimum with the market.

Speaker 5

Some of that's regional. But on average, we don't have enough of either to really grow with a 2 plus percent market and that's We have the containerboard to do that.

Speaker 1

Okay. Fair enough. I'll turn it over. Thank you, Mark.

Operator

Thank you. And next from Deutsche Bank, Kyle White. Please go ahead.

Speaker 10

Hi, good morning. Thanks for taking the question. In Industrial Packaging in North America, you talked about some of the labor challenges, but I'm just curious how you would Characterize your overall network from an efficiency standpoint versus maybe a year ago, you've had a lot of headwinds over the past year from disruption. Is there still more to go on that front in terms of making the network more efficient that could produce better margins and lower marginal cost production?

Speaker 5

Kyle, it's a great question. We're running very well right now. The issues we had in the mill system last year with Interruptions at the beginning of the year and the end of the year and our low inventories in our box plants, we've largely put all of that behind us. The box plants are running very well All the efficiency metrics like throughput, that the margin would generate per hour of production time. Where we are challenged is in certain regions, we just don't have enough people.

Speaker 5

So we end up making that up with overtime, Which is not a long term sustainable solution, a certain amount is, but not too much. So we need some plants that are not running As many shifts as they could be running for the demand, that's where people come in. And then in certain parts of the country, upper Midwest, The area in the Southwest Texas, we need more physical assets as well as people. And that's what we're working on, The assets through our CapEx investment plan and on the people side, working very hard to hire and retain new employees so that we can run out the assets we have in a more sustainable way, not just working every weekend and run them

Speaker 3

activity. Got

Speaker 10

it. And then at the Georgetown Mill, you have that supply agreement with Savamo that can be terminated here in the next 6 months or so. Any kind of early thoughts about that supply agreement?

Speaker 6

Yes, not right now. And I got them confused. I think Georgetown maybe a little bit longer. I think Riverdale is a little bit shorter. But yes, there's nothing new to report at

Speaker 10

Sounds good. I'll turn it over.

Operator

Thank you. Then next we go to KeyBanc and the line of Adam Josephson. Please go ahead.

Speaker 11

Mark and Tim, good morning. Thanks very much. Hope you're well. For either of you, can you help me with what your box shipment expectations were heading into the quarter compared to the down 3.6% that you experienced. And can you walk us through the progression of demand trends during the quarter and then into July and how that's informing your expectation that shipments excluding the one extra shipping day will be flattish sequentially?

Speaker 6

Yes. I think, obviously, we thought they were going to be a little bit stronger as we were going through the quarter. It seemed to The adjustments seem to take place in, I'd say, the second half of May and a little bit into June. I think it's a reaction to the things we talked about earlier. Inflation is real.

Speaker 6

People are making choices. And there's as we've read and heard and heard from our customers, there's a lot of inventory and pipelines that needs to be worked off. So But it seems to stabilize and seems to be stable around the same level as we go through July. So our view is Sequentially, it should be roughly flat quarter on quarter. Obviously, down a little bit versus last year, but stable quarter on quarter.

Speaker 11

Right. I appreciate that. But just the inflation, obviously, these pressures haven't gone away at all. In fact, if anything, All these CPG companies are just raising prices even more. Everyone's raising prices more, it seems like.

Speaker 11

So and obviously, Walmart just guided down and so they still have too much inventory of general merchandise because people are under so much pressure, the cost of food and consumables is up so much. So Those pressures don't seem to be abating in the least. So I guess why would box demand stabilize now?

Speaker 6

Well, we look at our mix of business and we talk to our customers and then we have the experience of how we ended the quarter and how it's continued in July. And so based on that, we have a view that through the Q3 and there's always some seasonal puts and takes, but we have a view that Within a margin of error, it should be roughly flat with what we had in the second quarter.

Speaker 11

Got it. Thank you, Tim.

Operator

Thank you. The next from Truist Securities, Mike Broxman. Please go

Speaker 3

ahead. Thanks, Mark, and thanks for taking the questions. Just wanted to get a sense, you mentioned faster implementation of the March price increase. What's driving that?

Speaker 6

Faster implementation? I think it's consistent with the Prior increases that were implemented. It's just it's security of supply and people want to get For the longest time, I wanted to make sure they had boxes and just making sure that There's no disruption to their operations. So, we the first price first several price increases The fastest we've seen on any historical comparison. And this last one seems to be going at the same pace.

Speaker 6

By the end of the Q3, we'll have most of it done. There's a little bit of residue or residual that falls over into the Q4. But So far, it's continuing as the prior increases did.

Speaker 3

Got it. And then just one follow-up from some of the prior questions in your commentary regarding some of this inventory destocking. Obviously, I realize there are puts and takes at some of the elements that you make their lines versus non variable, but also really that I assume you guys see some benefits from omni channel as well. So maybe you're getting some wins from increased maybe in store activity. So can you talk about any shift that you may make in your own business to offset the decline in e commerce and some of the markets you mentioned?

Speaker 6

I'm sorry, you broke up just a little bit. Could you just repeat the last part of that, please?

Speaker 3

Sure. I'm just wondering no problem at all. I'm just wondering if you're making any shifts in your business, to account for some of the weakness that you're seeing in your end markets. And realizing that there is They're putting takes with some of this inventory stocking, durable items versus non durable. So wondering if you're making any shifts in your business to offset those debt that weakness at the Capitalized and Possibly Growth Areas.

Speaker 6

Yes. Okay. Appreciate that. Yes. On the durables, it's really a very small part of our mix.

Speaker 6

And we're always looking we manage a very active S and OP process and we're always looking at how we run our system. I would say that while demand softened a little bit as we went through the second quarter. And our view is for it to be stable quarter to quarter. The supply chain constraints are real and it's And so part of the effort over the past years with those difficulties is to get inventories back to a sufficient level, which may be elevated to historical levels. I mean, we're looking at 4, 5, 6 days additional time to move product between mills and box plants.

Speaker 6

So it's very dynamic at the moment and we're just trying to make sure that The inventory levels we have are sufficient for this type of service requirements that we have to our customers.

Speaker 3

Thank you. Good luck on the quarter.

Operator

Thank you. Then next from Jefferies, we'll go to the line of Phil Ng. Please go ahead.

Speaker 12

Hey, guys. Tim, appreciate you highlighting the strength of your balance and the free cash flow profile of your business. Just curious from returning cash back to shareholders, which you guys have done a great job this year. How are you guys kind of balancing between Stock buybacks, just given where your stock is and then growing that dividend. And I guess, as we kind of look out to 2023, if there is a recession, your level of confidence of maintaining your dividend through a potential downturn.

Speaker 6

Yes. Well, we want the dividend to be sustainable. That is 1st and foremost, attractive but also sustainable. So we take a look at it. We're just starting the process now.

Speaker 6

We look at it on an ongoing basis, but in more depth over the summer. And we usually, if there are any changes or I think right now that's work to be done in the conversation with our Board and our Board is very active in terms of how We've tried to be very opportunistic and yes, it's a powerful number that we've returned so far for 6 months this year.

Speaker 5

Phil, if I could just add to Tim's comments. We really haven't changed the guidelines for our dividend After the changes in our portfolio, we still target the 40% to 50% of free cash flow. And we think that's the right amount. We continuously evaluate that with our Board. We listen to what investors have to say about it.

Speaker 5

What's different in our capital allocation, of course, Is the ability to consistently at the right value, have a share repurchase flow of cash back to shareholders. That's not episodic. It can be more consistent when it makes sense. The cash is there. And Tim talked about in in his prepared remarks around our ability to operate our system in different economic conditions.

Speaker 5

So wide open when it needs to be, less than wide open and shedding marginal cost. And so when we think about potential downturns, there's always a question How long and how deep? But just say a potential normal downturn, we have no concerns about the cash generation, the dividend or any of the real Important capital allocation, even CapEx. I mean, we've not been in a position to just say we're going to go and we're going to do what's right for the long term of And we feel very good about that right now.

Speaker 6

Got it. That's good. There are and I don't know if we're There are countercyclical benefits that offset sometimes downdrafts and economic activity, both for earnings and cash. When you think about input cost on the earnings side, you think about working capital on the cash side.

Speaker 12

Super. And then Mark, I mean, your point about how you guys have Kind of retooled the footprint and manage that fixed cost variable cost dynamic is important. It was actually my next question. Remind us if you had to take economic downtime to kind of keep the market balance, how should we think about that flow through? I mean, I think I have a Pretty dated number, but I thought it was roughly in that $150 per ton range if you had to take downtime to kind of keep things balanced.

Speaker 12

But give us an update, that would be super helpful.

Speaker 5

I think that's still a reasonably good number. I mean, there's obviously some noise in the variable cost side of Given all the inflation, but I think that's probably still a good number from a modeling or planning standpoint. It obviously won't be exactly that, but it's in the neighborhood.

Speaker 12

Okay, super. Thank you. Appreciate the color.

Operator

Thank you. Then our last question will come from UBS and the line of Clive Rooker. Please go ahead.

Speaker 4

Hey, great. Good morning, everybody. Thanks for taking my question. Appreciate it.

Speaker 10

I don't want to Split hairs here, but

Speaker 4

I did notice on the margins in Industrial Packaging, it looks like there was a slight change in the slides on the timing of the sort of 20 and target that 20% plus target you're laying out there. You don't seem to be highlighting the second half anymore. First of all, I was wondering if that was intentional and if it was given the pricing and confidence in the BuildBetter IP, should we take to mean that the ongoing cost inflation is just resulting in a little bit more uncertainty on the margin?

Speaker 6

Yes. I think that we had More input cost pressure in the second quarter and we see that continuing at a slower pace, But continuing on the 3rd, we think it does stabilize, level out as we go through the second half of the year. But I think It's just it's not anything more than just timing based on swift movement of inputs and it takes a little bit longer to recover as we continue to implement the price increase.

Speaker 4

All right. Okay. That makes sense. Thanks for the clarity. And then I guess just following up quickly on the costs.

Speaker 4

In the prepared materials, you say distribution in the cost stabilize at elevated levels. I think in the quarterly bridge, we talked about another maybe about $100,000,000 to $100,000,000 of sequential headwinds going into Q3. I mean just to clarify that ultimately as you're thinking about it right now, does that when we're thinking about the bridge from Q3 to Q4. Is that input cost sort of flat, which I think you're sort of alluding to, but just Clarify that. And then I'd just be curious if there are any areas where you're starting to see costs release?

Speaker 6

Not significant amounts of cost really. It seems some things flatten out and moderate just a little bit As we went through the Q2 and now that we're in July, but I think the way that you framed it up is How we're thinking about it, we see some more input cost pressure at a slower rate of increase in the 3rd quarter than we saw in And then I think as we go through late Q3 through Q4, we see more stabilization at these elevated levels.

Speaker 4

Yes, that makes all right. Thank you very much. I appreciate it. Thank

Operator

you. And I will now turn the call over to Chairman and CEO, Mark Sutton, for closing remarks.

Speaker 5

Thank you, operator. Thank you for being with us today. As you can tell from our remarks and some of the Q and A, we're very confident and optimistic about the future of IP. We've reaffirmed our 2022 earnings outlook. We're making strong progress.

Speaker 5

We have a lot of momentum as we focus on building a better IP. We'll be at the upper end of that savings and earnings commitment for this year and we'll be well on our way into the targets we set for 'twenty three on that initiative. We've got a balance sheet and an overall financial strength of the company that we haven't had in a long time. That gives us a lot of flexibility. It also gives us a lot of ability to manage through the different economic scenarios that everybody is We think we're ready for just about anything that can come, and we're going to perform very well through any scenario that we have in front of us.

Speaker 5

We think this all leads to our ability to really break through and accelerate value creation for our shareholders with a strong company, With a great employee team and the right and the ability to invest in the right ways without regard for any kind of temporary economic changes really positions us very well. So again, I thank you for your interest in International Paper, and we look forward to speaking with you again at the next quarterly update. Thanks.

Operator

Thank you for your participation in International Paper's Q2 earnings call. You may now disconnect.

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Earnings Conference Call
International Paper Q2 2022
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