International Paper's second quarter 2023 earnings call began with an introduction from Mark Nellessen, Vice President of Investor Relations. Mark Sutton, Chairman and Chief Executive Officer, and Tim Nicholls, Senior Vice President and Chief Financial Officer followed with a discussion of the company's results. The company's Building a Better IP initiatives delivered $55 million of year-over-year incremental earnings benefit and is on track to exceed its full year target for the second year in a row.

In the second quarter, underlying demand for the company's products improved, but remained constrained by inventory destocking. Consumer priority focused on services and non-discretionary goods, resulting in lower volumes and prices. Margins were under pressure, but partially offset by lower input and distribution expenses. The company returned $200 million to shareholders, and is still awaiting approval from the Russian Competition Authority for the sale of its Ilim investment.

In the second quarter, the company generated $261 million of free cash flow and operating earnings per share was $0.59. Pricing mix was lower due to index movements and lower export prices, but volume was flat as improved demand in Industrial Packaging was offset by weaker demand in Global Cellulose Fibers. Maintenance outages were lower by $88 million and input costs were $83 million lower, mainly driven by lower energy, wood and distribution costs. Industrial Packaging saw a lower price and mix due to index movements and lower export prices, however, volume was higher despite one less shipping day due to improved demand.

In the second quarter, box shipments were down 8.3% year-over-year due to inventory destocking by customers. June showed an improvement of 5.9%. The lower demand environment impacted production and costs, resulting in economic downtime and lower planned maintenance outages. Input costs were also lower, resulting in a $66 million improvement in earnings. In order to optimize their systems, the company is reducing fiber costs, freight carriers, and warehouse expenses. Inventory destocking is still progressing for their customers.

Inventory destocking across the supply chain has caused a large portion of overall declines in demand this year, and is lasting longer than expected. 75% of customers entered the third quarter with lower inventory levels than target. The majority of retailer inventory destocking was completed in the first quarter, while manufacturers are still reducing inventories in the second quarter due to lower demand levels, improved supply chain velocity, and focus on working capital. Global Cellulose Fibers experienced lower price and mix in the second quarter due to price index movements and higher levels of commodity grades, as 85% of their products are exported. Fluff pulp shipments were weaker due to inflationary pressures and lower consumer demand for absorbent hygiene products.

In the second quarter, inventory destocking across the long supply chains and the resulting decrease in customer safety stocks caused a decrease in business earnings. Sequentially, operations and costs improved due to lower distribution costs, seasonally lower energy consumption, higher residual energy sales, and lower input costs. The company has a strong balance sheet and returned $200 million to shareholders in the second quarter. Going forward, they are committed to maintaining their dividend and investing in excellence to grow earnings and cash generation.

In the second quarter, the company invested $267 million in their businesses and plan to make additional investments across their box system to support long-term profitable growth. For the third quarter, price and mix are expected to decrease earnings by $95 million and $40 million for Industrial Packaging and Global Cellulose Fibers, respectively. Volume is expected to increase earnings by $5 million and $10 million, respectively. Operations and costs are expected to increase earnings by $95 million and be stable, respectively. Lower maintenance outage expense is expected to increase earnings by $28 million and $12 million, respectively. Lastly, rising input costs are expected to decrease earnings by $15 million and declining input costs are expected to increase earnings by $10 million, respectively. For the full year outlook, more details will be provided on Slide 12.

IP is making progress in its building a better IP initiatives, resulting in $55 million in year-over-year incremental earnings improvement in the second quarter and a total benefit of $120 million year-to-date. The company is targeting a full year 2023 EBITDA of $2.1-2.3 billion, free cash flow of $500-600 million, and CapEx of $1.1-1.2 billion. They expect to exceed the original target for the initiatives this year.

The lean effectiveness initiative has contributed $116 million in cost savings since 2020, when the company began its building a better IP program. The majority of benefits will come from strategy acceleration and process optimization initiatives, which are focused on creating value through commercial strategies and leveraging advanced technologies. In the industrial packaging business, the company is reducing high marginal costs, investing in the box business to expand capabilities and improve productivity, and leveraging new investments and market expertise to improve mix and capture additional value.

The company has implemented new technologies and capabilities to reduce costs and increase efficiency across multiple categories. Additionally, they have earned a higher premium for fluff grades due to their revised go-to-market strategy. Despite these successes, they are currently facing a challenging business cycle and inventory destocking, which is masking the benefits of their efforts.

International Paper is working on several key areas to navigate the current economic environment while driving profitable growth over the long term. They are focused on creating value for customers, reducing exposure to commodity grades, and optimizing their cost structure. The company is well-positioned for success due to their strong financial foundation and talented employees. The senior business leaders are available to answer questions during the question-and-answer portion of the call.

Tim Nicholis explains that the majority of the reduction in EBITDA outlook is due to a decrease in prices, both on the index and in the export and spot markets. Mark Sutton and Clay Ellis then discuss the initiatives that Global Cellulose Fibers has undertaken to help them overcome the price headwinds despite the soft demand.

Clay Ellis discussed the company's strategies for maximizing cash generation and minimizing costs, such as idling the Pensacola Mill and managing machine downtime. He also mentioned that they are looking to mitigate their exposure to commodity grades and are doing so through conversations with customers and surveys.

Mark Sutton and Tom Hamic discuss the metrics of shipments and bookings, and how they are indicative of the destocking process. They have a representative sample of customers that they use to measure inventory levels and demand patterns, and they have seen shipments improve by mid-single digits in July. The comps are becoming easier as well.

Tom Hamic explains that mid-single digit growth is a positive from quarter-to-quarter, and that this is a good representation of how customers are viewing the market. Mark Sutton then explains that in terms of pulp, IP has idled to consolidate downtime and taken huge amounts of downtime in containerboard during the second quarter. However, due to the mix of virgin and recycled fiber in the other containerboard mills, IP believes that the way they have been managing the containerboard system has resulted in the lowest marginal cost.

Tom Hamic and Mark Weiintraub discussed how the company evaluates the duration of a mismatch between their capacity and order book. They also discussed how they make decisions based on the marginal cost of loading mills and how they analyze scanner data to determine the retail takeaway of box-intensive goods. The analysis suggests that the retail channel is between -2% and +1% year-over-year.

Tom Hamic and George Staphos are discussing the impact of the pandemic on the perishability of different segments of the market, with durable and non-durable goods being the most affected. Hamic believes that the health of the consumer will not have a negative impact on box demand, as customers have been stocking up on items with a long shelf life. Staphos is curious as to the impact of this on EBITDA in 2024, as Hamic has already stated that they will be adding 150-125 new IPs in 2021. Hamic does not provide a definitive answer, but it is implied that the impact of the price index changes and the new IPs will be positive.

Tim Nicholls discussed the difficulty of quantifying the effect of prior price changes on EBITDA for next year, due to changing mix. He noted that there are initiatives in place to mitigate the carryover, and that they typically give their outlook for the year in the fourth quarter call. He concluded by stating that they feel good about the company's self-help measures going into 2024.

International Paper (IP) needs to see an earnings recovery, which requires a balance between price and cost, and a margin structure of over 20%. To track this, IP looks at EBITDA per ton, which is impacted by macro-level factors such as the amount of volume in the market, as well as commercial factors such as the customer mix and contractual responsibilities. Inflationary costs have caused a margin squeeze, and IP must now undo this. To do so, the market must not decline at the same rate it started.

Mark Sutton and the team are confident that their product lines will have long-term growth, but they are unable to control overall demand. They are focused on who they sell to, the price they sell at, and how they operate their manufacturing facilities to be cost-effective. Cleve Rueckert asked about volume growth in the packaging business, to which Mark Sutton asked Tom to comment, as well as Jay Royalty who could speak to container board in the open market and export channels.

Tom Hamic and Jay Royalty both expect to see an improved second half of the year compared to the first half, with the destocking effect playing a big role. In the domestic channel, they are seeing modest improvement in the second quarter and are encouraged about the third quarter. In the export channel, inventory levels and order patterns have started to stabilize, with improvement being seen across all three regions. The current order bookings show a 200,000 ton pickup in the run rate of the second half versus the first half.

International Paper's commitment to its dividend is not a formulaic one, but one that is important to its shareholders. They are confident that they can grow back into the dividend range with future cash flows, even if the dividend is at the upper end of the range for a short period of time.

The company is committed to its dividend in good times and bad, and is not arbitrarily making changes to it. The $500 million to $600 million includes a one-time settlement payment for timber monetization, and the company is investing more capital than it has since before the pandemic, with the range being 1 to 1.2 billion. A big portion of the initiatives the company is working on are cost-related.

Tim and Mark discussed the ability to flex their capital spend if needed, as well as the investments they are making in their box business and converting operations which will produce future cash flows. Anthony asked if the capacity additions this year have been more or less disruptive than expected, and if the impact has been absorbed in the market.

Jay Royalty from International Paper discussed how customers buy boxes and require a complex set of needs and a complex offering. He noted that new entrants are coming in with a limited set of offerings and that International Paper provides a more robust offering with multiple grades and redundancy in their supply chain. On the other hand, Gabe Hajde from Wells Fargo discussed the $2.8 billion of price realized in the Industrial Packaging business in 2021 and 2022. He noted that on a year-over-year basis, there is an implied decrease of $125 million.

Tim Nicholls explains that the rate of price change in the Industrial Packaging segment was atypical this year, with three price increases in a 12-month period. He suggests following up with Mark and IR to model out the flow-through of the price changes going forward.

Mark Sutton explains that it is difficult to give an update on the timing of the cash coming in for the IP Ilim transaction, as they are still awaiting approval from the competition authorities. He notes that the transaction is on the larger end of things that have occurred and thus it requires higher levels of scrutiny and approval from higher-level officials. He states that the potential buyers are working their contacts with the government to try and get the transaction to the finish line, but he cannot give a better timing due to the current situation in Russia.

Clay Ellis comments on the phenomenon of substitution in the Global Cellulose Fibers business. He notes that disruption in the supply chain in 2022 increased the rate of substitution in certain geographies and segments. He specifically mentions pet pads in parts of China as an example of a product where brands and high-quality product performance are not as critical.

International Paper discussed the increase in the fluff market in the first half of 2023, as well as the decrease in the second quarter due to changes in spot market prices. They believe that this segment of the market is unlikely to grow broadly, but it is not a new phenomenon. They are focused on initiatives that will help the company in the future and will update everyone on their progress during the next earnings call.

This summary was generated with AI and may contain some inaccuracies.