Packaging Corporation of America (PKG) Q3 2022 Earnings Report, Transcript and Summary

Thank you for joining the Packaging Corporation of America’s Third Quarter 2022 Earnings Results Conference Call. Your host today will be Mark Kowlzan, Chairman and Chief Executive Officer of PCA. [Operator Instructions] I would now turn the conference over to Mr. Kowlzan. Please proceed when you are ready.

Thank you, Matt. Good morning and thank you all for participating in Packaging Corporation of America’s third quarter 2022 earnings release conference call. I’m Mark Kowlzan, Chairman and CEO of PCA and with me on the call today is Tom Hassfurther, the Executive Vice President, who runs our Packaging Business and Bob Mundy, our Chief Financial Officer. I’ll begin the call with an overview of our third quarter results and then turn the call over to Tom and Bob, who will provide more details. I’ll then wrap things up and then we’d be glad to take questions. Yesterday, we reported third quarter net income of $262 million, or $2.80 per share, excluding special items third quarter 2022 net income was $266 million, or $2.83 per share, compared to the third quarter of 2021 net income of $257 million or $2.69 per share. The third quarter net sales were $2.1 billion in 2022 and $2.0 billion in 2021. Total company EBITDA for the third quarter excluding the special items was $477 million in 2022 and $464 million in 2021. Third quarter net income included the special items expenses of $0.03 per share primarily for certain costs at the Jackson, Alabama mill for the paper to containerboard conversion related activities, details of all special items that for the third quarter of 2022 and 2021 were included in the schedules that accompanied the earnings press release. Excluding the special items, the $0.14 per share increase in third quarter 2022 earnings compared to the third quarter of 2021 was driven primarily by higher prices in mix in our packaging segment of $1.60 and pay per segment $0.23 cents. Lower interest expense, $0.04, a lower share count resulting from share repurchases, $0.04, and the lower tax rate, $0.02. These items were partially offset by operating costs which were $0.70 per share higher primarily due to inflation related increases in the areas of energy, repairs, materials and supplies, chemicals, labor and benefits expenses, as well as several other indirect and fixed cost areas. We also had inflation related increases in our converting costs which were $0.04 per share higher. The negative impact of lower volume was $0.52 per share in our packaging segment, and $0.05 cents in our paper segment. Freight and logistics expenses were $0.20 above last year, and scheduled outage expenses were $0.10 higher. We also had higher depreciation expense of $0.07, and other expenses of $0.04. The results were $0.03 above the third quarter guidance of $2.80 per share primarily due to the very sound implementation processes around our previously announced price increases in the packaging and paper segments, as well as the continued benefits generated from our mills and plants through process efficiency optimization efforts and material usage initiatives. Looking at our packaging business, EBITDA excluding special items in the third quarter 2020 of $467 million, with sales of $1.9 billion resulted in a margin of 24.1% versus last year as EBITDA of $467 million with sales of $1.8 billion and 25.5% margin. Our teams did a tremendous job of implementing our previously announced price increases. However, demand in our packaging segment was well below our expectations for the quarter. Tom will discuss this further in a moment. The containerboard mills operated in an efficient and cost-effective manner as we balanced our supply with current domestic and export demand. As part of the effort, we began the scheduled maintenance outage in the first phase of the No. 3 machine conversion to containerboard at our Jackson Alabama mill a few weeks earlier than originally planned. Total economic related downtime for the third quarter was approximately 128,000 tons. The outage and conversion work at Jackson will be completed in the fourth quarter. And we will remain committed to ramping up our internal capacity according to our customers demand requirements. Finally, although we are still experiencing historically high inflation within our operating and converting costs, our mills and plants continued to remain focused on delivering numerous cost reduction initiatives, efficiency improvements, and integration and optimization enhancements and capital benefit -- capital project benefits that helped minimize the impact. I'll now turn it over to Tom who will provide more details on the containerboard sales and corrugated business.

Thank you, Mark. As Mark mentioned, we continue to get excellent realization from the implementation of our previously announced price increases across all product lines, domestic containerboard and corrugated products prices and mix together were $1.54 per share above the third quarter of 2021 and up $0.35 per share compared to the second quarter of 2022. Export containerboard prices and mix were up $0.06 per share compared to the third quarter of 2021 and up a $1.00 per share compared to the second quarter of 2022. The lower demand in our packaging segment that Mark spoke of was driven by several items, the combined impact of which resulted in our volumes being much lower than we anticipated. Corrugated product shipments were down 6% in total and per workday, compared to last year's third quarter. Outside sales volume of containerboard was 57,000 tons below last year's third quarter and 61,000 tons below the second quarter of 2022. The ongoing inventory correction in the retail channels is larger than originally thought and significant inflation continues to negatively impact consumers purchases at both durable and non-durable goods. In addition various events and issues in 2021 and this year, including the recent hurricane in Florida, continue to have a negative effect on the agriculture and protein markets. Demand is beginning to experience headwinds from the cooler housing markets as well. These things combined with rising global interest rates, deterioration in US economic conditions, economic weakness in China and Europe. Along with China's zero tolerance COVID policy all negatively impacted domestic containerboard and box demand. As we look from the third quarter and into the fourth quarter, we expect the majority of these conditions to continue. And in addition, there are four less shipping days in the fourth quarter compared to the third quarter. Now I'll turn it back to Mark.

Thank you, Tom. Looking at the paper segment, EBITDA excluding special items in the third quarter was $33 million, with sales of $165 million or a 20% margin compared to the third quarter of 2021 EBITDA of $18 million, and sales of $150 million or a 12% margin. Prices and mix were up 21% from last year's third quarter and moved 6% higher from the second and into the third quarter of 2022 as we continue to implement our previously announced price increases. Sales volume was about 9% below last year's third quarter primarily due to this year's scheduled outage at our International Falls mill as well as last year's third quarter that included paper sales from the Jackson mill's No. 1 machine. The outstanding efforts around implementing our latest price increase, together with optimizing the cost structure, inventory and product mix delivered excellent margins in the paper business. Now I'll turn it over to Bob.

Thanks Mark. Cash provided by operations and free cash flows at all time quarterly records at $431 million and $251 million, respectively. The primary payments of cash during the quarter included capital expenditures of $180 million. Common stock dividends totaled $117 million, $77 million for federal and state income tax payments, pension and Other Post Employment benefit contributions of $51 million and net interest payments of $4 million. In addition, we repurchased 1,032,000 shares during the quarter at an average price of $137.60 per share, for a total of $142 million. We ended the quarter with $794 million of cash including marketable securities, and our liquidity on September 30, was $1.1 billion. Lastly, our planned annual maintenance outage expense for the fourth quarter is now expected to be about $0.38 cents per share, or $0.11 cents per share higher moving from the third quarter to the fourth quarter. I'll now turn it back over to Mark.

Thank you, Bob. Looking ahead as we move from the third and into the fourth quarter as Tom mentioned, we see most of the issues and economic conditions and higher global interest rates that impacted third quarter packaging segment demand continuing. Our box plants will have four less shipping days compared to the third quarter. And we also expect a seasonally less rich mix in corrugated products as well as lower average export containerboard prices. We will run our containerboard system based on this demand outlook along with completing the Jackson, mill scheduled annual maintenance outage in the first phase of the containerboard conversion work on the No. 3 machine. In our paper segment, we will continue to implement our previously announced $60 per ton price increase on all office printing and converting grades that took effect on September 6. However, volume will be lower compared to the seasonally stronger third quarter. As Bob mentioned, scheduled annual outage expenses will be $0.11 per share higher than the third quarter. Lastly, we expect slightly higher operating costs, primarily labor and benefits expenses, along with anticipated colder weather resulting in higher energy costs. Considering all of these items, we expect fourth quarter earnings of $2.22 per share. With that we'll be happy to entertain any questions but I must remind you that some of the statements we've made on the call constituted forward-looking statements. The statements were based on current estimates, expectations and projections of the company and involve inherent risks and uncertainties including the direction of the economy and those identified as risk factors in our Annual Report on Form 10-K and subsequent quarterly reports on Form 10-Q filed with the SEC. The actual results could differ materially from those expressed in the forward-looking statements. And with that Matt, I'd like to open up the call for questions please.

[Operator Instructions] Our first question will come from George Staphos with Bank of America Securities.

Hi, this is Sandy Liang on behalf of George Staphos, he had a small conflict. First, can you please discuss your early 4Q booking and billing trends? And to the extent that you can share are customers continuing to destocking the supply chain? Thank you very much.

Sandy, this is Tom. Good morning. So far, our bookings and buildings are running about 5% below last year. The, you asked about stocking and some inventory issues. I will tell you that I think the good news is, well, first of all, we didn't predict that it would last as long as it is in terms of this inventory issue. There was obviously coming out of the pandemic retailers and other customers stocked up significantly to try to meet the record-breaking demand that they saw and wanted to o maintain that. And of course, that demand has now waned some. In addition, we find that they ordered excessive number of boxes as well to meet that kind of demand. So we are going through this period right now of pretty severe inventory adjustment. That's what we're seeing primarily in these down volume numbers. And that's going to take a while to work through the system. We thought that it was going to work through the system and about 30 or 60 days. But this looks like it's going to be probably a couple of quarters to get through this completely.

Our next question will come from Mark Weintraub with Seaport Research Partners.

Thank you. So following up on the demand questions. Could you ballpark and I realize this is just judgment, but yours is certainly going to be as good or better than anybody else's? How much that inventory destock might have contributed to the down 6% realizing there are other factors you highlighted as well.

Mark, this time again, it's significant. There's no question about it. And it's the primary number. It's quite interesting that just -- as of yesterday, as a matter of fact, I mean, we had a fairly large customer at one of our plants, who sent an email in and said, I have finally run down my excessive inventory. I'm now ready to order again. So we probably lost in a lot of cases, one or two of the typical order cycles that some of these customers would go through as they went through this destocking of inventory.

And then you mentioned you thought, where it is originally 30 to 60 days, maybe it's going to be a couple of quarters. So is that your best? Is it right to interpret that as meaning we had it in the third quarter and you're hopeful that we'll run -- we'll be done with it through the fourth quarter? Or might it go beyond there? And do you anticipate it's going to be continuing at as high level as what we saw in certainly that the latter part of that third quarter?

Well, obviously, I can't predict the future. But I can tell you that. I believe that when you look at our fourth quarter, as I mentioned, there are a lot of other factors going into the fourth quarter and including this destocking. So if you look at those numbers, and you think about those, you would see that the trend is probably we'll begin to work our way out of this inventory issue. But we've got some other headwinds as well, as I mentioned, especially like the ag business in the south that was impacted by the hurricane, and that those crops are either going to be delayed or in some cases lost completely. So we, I, the only -- I've never experienced this, to be honest with you in my entire career. So this severity of this building the inventories, the lead times, the box plants got to and kind of in some cases almost a panic buy boxes because they couldn't ship their products without it obviously. So it's just going to take a little while to work through this, I look back at the great recession. And it was kind of interesting there because in the Great Recession, it took a couple of quarters for the cycle to finally turn and the business to really turn up beginning it still wasn't equal to the previous year that took a few more quarters. But the first two quarters were the big jumps. So that's the only thing I've really got it to compare to. And so I think when you think about how many boxes somebody can store, or how much product they can have and get rid of, I would think that through this Christmas season, you'll see a lot of destocking take place.

Our next question will come from Adam Josephson with KeyBanc Capital Markets.

Thanks so much, everyone. Hope you're well. Tom, just one more question about that the, are you seeing it at the retail level at your customer? To your point, I just -- I wouldn't think that your customers could store would have room to store that many boxes. So I'm just a little perplexed as to where exactly that destocking is taking place and how much longer it could last for?

Well, let me get specific on that. Adam. I mean, what we're talking about destocking is we're talking about customers that built their own inventories of their own products, to hopefully continue to meet a demand curve, that was quite steep and quite good for them. And all of a sudden, when that demand leveled out, they're sitting on a lot of their own inventory, that coupled with the lead times that got out in boxes, they had to store more boxes as a result of those lead times. And those lead times have now come back down to a more normal level. So just be it by coming back down to a normal level you can miss a whole order cycle.

Got it, okay. But even though they've come back to normal lead times, they're still sitting on, it seems like much too much inventory for --

Yes, in some cases, yes. I just told you about a big a large customer, one of our plants that is now ordering again, but they didn't order. I gave you another example, a very large account of ours, through mid-year was up about a little over 3%. And suddenly, the next month, it was down 50%. Now, this isn't lost business, this isn't anything other than just they've got --they have excessive inventory, that they're going to have to work off for a while. So we got to get through this cycle.

Yes, no, I appreciate that. Bob, just on the guidance, can you just walk me through the implied sequential change that the $0.60 decline? I believe you said maintenance is going to be $0.11 higher sequentially so leaves another call it $0.50. Can you help me with how much is inflation? How much is lower containerboard export? How much is the Jackson conversion work, et cetera? And then within that, Bob, how much would you consider essentially onetime items, for instance, elevated maintenance relative to normal, et cetera? If you catch my drift?

Yes, Adam. I'll say as Mark mentioned in his comments, we expect to run our containerboard system similar to this -- with the same types of issues we had in the third. So when you consider that I'd say about half of that sequential movement will end up in the volume side of so in the balance of that -- the items that are probably higher versus what we would normally see going from third quarter to fourth quarter, really a couple of buckets, primarily energy for obvious reasons, and labor and benefits again, for some obvious reasons as that continues to just increase with the situation with the labor force. I'd say one other item that might be a little bit different as well is on the freight side, we certainly are seeing some improvement in the freight world right now. But when you're matching supply with demand, you're not always able to optimize your routes, and you may be shipping things more on one mode versus the other than normal or for longer distances. So that is a reason that we expect that to be up a bit going from 3Q to 4Q.

Yes. I appreciate that. And Mark just on the buyback. And correct me if I'm wrong, but I think the average price of 137 was comparable to what you did in 4Q of last year. Were you doing that as demand, like before, after demand did what it did. And I'm just wondering about your thoughts about where the stock is now versus what you've been paying for buybacks in recent quarters, in light of the recent demand weakness and otherwise.

As we went through the third quarter, we saw an opportunity based on where the stock price was at the time that it was a good value for us to buy back. And we look at it as a conviction opportunity that we see the value there. We have the cash and took advantage of it. It is historically in line with what we did last year at this same time in the fourth quarter. And long term, I think under the circumstances, we will continue to take advantage and be opportunistic in the same manner.

Just one last one on that. If you were to compare potential acquisitions to further buybacks, is there one, at this juncture that's looking more attractive to you than the other or not necessarily?

Not necessarily. Again, I think, again, we see value in terms of the stock buyback during the third quarter. And so you would have to imagine where the stock is today, we have that same type of conviction. And so we'll update you on the January earnings call on what we actually did. But I think you have to understand, if we do hit the $2.22 number that we're guiding to, we're going to have an $11 earnings year. And so it's going to be a record year for us once again. And so again, I'm going to use the term conviction, we believe strongly that there's a much higher value in the embedded in the stock valuation.

Our next question will come from Phillip Ng with Jefferies.

Hey, Mark, Tom, Bob, this is John [Inaudible] on for Phil. Appreciate the color, I want to start off with your own inventory levels. I mean, they picked up sequentially ahead of the day three outages as you're planning. But obviously the demand outlook has worsened quite a bit. Can you just give us some color on how you're viewing your own internal inventory levels on the containerboard side, and is there any economic downtime baked into your guidance?

When we went into the third quarter, we historically, third quarter is always a robust quarter, people are getting ready for holiday activity. And so you also come out of the second quarter, which is traditionally a bigger annual outage quarter when you've taken mills down and you run your inventory down to the lower side. So you will always try to start building back up during that July-August period, which is what we did. Obviously, the demand did not materialize. So we course corrected and ran to demand. And so we will continue to do this. I think as far as inventory targets, we don't have a specific target as such, we're looking at what Tom is understanding about what the market is doing on his side of the business and what we would imagine we would need to supply that. And we will continue to run our mills in that regard to meet the demand. We got a lot of flexibility. We will be finishing up the Jackson work sometime in November. And then we will again be using the term run to our demand.

Understood. I guess leading up to this quarter, you had talked about being still pretty tight on inventories. Obviously, there's of course correction, I'm sure there it's a little bit of a moving target in terms of the inventory levels. But I guess my takeaway is that you're feeling comfortable with your inventory levels. Now there isn't some big destock that you feel like you have to do yourself with the pullback on the demand side.

No, we're in a good place, and again, we're at a place now we can move the tons and inventories where we see we need to move. So we're in a healthy place.

Great. Okay. And then just shifting over to the paper side. My expectation I thought from last quarter was that paper volumes would be about flat sequentially in the third quarter. Obviously, it came in much higher seasonally stronger quarter. Was there anything that kind of stood out on the paper side for drivers that we should expect maybe going forward?

No, just again it was good quarter for us. We've also right size, the business we've got International Falls, running in a manner now in terms of its split between cut size and offset converting type grades. And so we're in a good place there. We worked off the final inventory from the Jackson production that was produced last year. So we see the market is in a balanced place right now. And we're capable of supplying the nationwide demand we have.

Our next question will come from Anthony Pettinari with Citi.

Hi, good morning. Hey, we've seen a big step down in OCC over the last couple of months. And an understanding you have more of kind of a version levered system, I think you've made some investments in recent years to add flexibility there. I'm just wondering if you can remind us how much OCC, you can consume, how much you can swing into potentially to take advantage of some of these low costs. Any thoughts there?

I think the best way to look at it is on a percentage basis, if you think about the total capacity of our mills system would still be around at 20%, low 20% capability of fibering up our mills. And so it's whether at a point in time with pricing, you're running 15% recycled to the system, or taking advantage of opportunities on pricing availability, and ramping it up into the lower 20% recycle. I think that's how we look at it. And that's the kind of capability we have.

Okay, that's very helpful. And then there are some competitor capacity projects that maybe will come online by the end of the year or early next year. I think some of those have explicitly targeted the independent box market. You have a very high integration rate I guess, to the extent that you can, are you seeing any of that new capacity in the market? Or entering discussions, or does your integration rate kind of insulate you from that? Just any thoughts about some of these new projects and impact on the market whether you're seeing it or not?

I'll let Tom comment on it.

Anthony, we are at number one as you summarized it correctly based on our integration level. That's been a target of ours, a very high integration level. That's where we come from. What and we've said many, many times, what other people decide to do and the investments they decide to make that strictly up to them. And we've talked about what we see the independent market being or the quote, unquote, open market, and what's happened to acquisitions over the last decade or more. That's -- that market has changed quite dramatically in terms of size. So I would just say that it's really, it's, we're a little bit ambivalent to what others decide to do.

Our next question is a follow up from Adam Josephson with KeyBanc Capital Markets.

Thanks so much, everyone. Tom, I was just one more thought which is in 3Q shipments were down six and you're talking about issues, yes, in 4Q your time up, bookings and billings down about five. Can you just remind me how that compares to 2019 levels? And what you think a reasonable expectation for demand is at this juncture, relative to '19 level, there have been obviously, so many distortions at the onset of the pandemic and thereafter. I'm just wondering how you're thinking about that issue?

Yes, well, Adam we will still be quite a bit above 2019 levels. So in spite of this, and I think that a big portion of this is as I said, inventory restocking. So I haven't changed, I really haven't changed my viewpoint, even from the last call we had, in terms of that we will retain quite a bit of the gains that took place during the pandemic going forward. This isn't severe demand destruction or anything like that, obviously, inflations have taken some toll. But this is more of a couple of quarter phenomenon, I think regarding these excessive inventories.

And what gives you confidence in that, that you would hold some of the volume you gained, post 2019, just again, given that there was this extraordinary surge with all the government stimulus, you name it, and now we're seeing the other side of that. So I guess what would give you confidence that you would hold those post 2019 gains, if you will?

Well, a couple things, no different from you having a discussion with me about my viewpoints, I have the same discussions with our customers about their business and about what they project going forward. And based on their forecasts, and what they see and what they expect to be doing in their business, the capital investments that are making in their businesses, et cetera. I have a high degree of confidence. The other thing that gives me some confidence is regarding the consumer themselves, consumer spending and the consumer relative to savings and other things like that is held up pretty well, in spite of this big step up in inflation. So I think some of these things, some of these phenomena we're dealing with here in the short term are going to wane, and it's going to be relatively positive going forward.

I appreciate and just went I think you mentioned that the impact that COVID lockdowns are having, yes, COVID lockdowns in China, excuse me are having on domestic demand. Can you just talk about just give your perspective as to the impact on the US economy from what's happening in China?

Well, interestingly enough we set the all-time record for onshoring of manufacturing, just in the last quarter in the US. It's not talked about very much. And it's a little subtle, but certainly very impactful for our business. And I think that'll continue to be the case. I can tell you that supply chains are still a big problem. It's been -- it continues to be a problem for our customers who rely on certain parts or chips or whatever the case might be coming from China, and the continuous disruption of that supply. That's beginning to really drive more onshoring not only here in the United States, but in Mexico and other related countries that border the US, which will be much more beneficial going forward for our box business.

[Operator Instructions] Our next question will come from Mark Weintraub with Seaport Research Partners.

Thank you. Just, first of all, just a clarification, you had mentioned that outages, I think we're going to be about $0.11 higher than you had previously anticipated in the fourth quarter. Did I hear that right? What is that number kind of on a per share basis expected to be in the fourth quarter versus the third quarter?

Mark, it's $0.11 going from the third quarter into the fourth quarter.

Got it. So it was like $0.26 or so in the third quarter going to $0.37.

It was, yes, it was like 20, yes, $0.26, $0.27, yes

Okay. Very good. And then the other question I have is, with the Jackson project, and one of the things that was also going to do was reduce your costs meaningfully? And hopefully under a certain environment that would show up in 2023. Is that dependent on demand, getting back to strong levels? Or are there ways you can run your system that benefits is going to show up regardless, do you think or, again, if it that, it'll show up? But we'll have to wait until that demand is back to stronger levels?

Yes, you just answered your own question. When you run the mill, the way it's designed in the way we're finishing up the work that we're doing, it will be a low-cost operation for us. And so we built that capability into it, and we'll be able to take advantage of it. But as we stand by the position that we will run the entire system to demand and that means rationalizing from a nationwide point of view where we need the tons to come from.

Okay, so basically, for the full benefit, obviously, you need demand to get stronger. That's the right conclusion.

Yes.

Okay. Thank you. Mr. Kowlzan, I see there are no more questions. Do you have any closing comments?

Yes. Thank you for joining us on the call today and we look forward to talking with you in January for the full year fourth quarter earnings event. Take care. Have a good holiday.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.