Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

International Paper Company (NYSE:IP)

2013 UBS Global Paper and Packaging Forum Conference call

September 12, 2013 9:00 am ET

Executives

John V. Faraci - Chairman and Chief Executive Officer

Analysts

Gail Glazerman - UBS

Gail Glazerman - UBS

I'm sorry about the delay on the webcast. Happy to introduce John Faraci, Chairman and CEO of International Paper. Clearly, there's been a lot of news over the last few days, so look forward to John enlightening us a little bit on some of those decisions.

John V. Faraci

Thank you and good morning. I'm going to be pretty brief this morning. I'll talk for about 10 minutes, but I want to leave most of the time to answer your questions. Let me first start by, I think, highlighting what International Paper is all about. We've been saying, and it is still one of our key messages that we have considerable runway with the current portfolio at International Paper to generate more EBITDA than we are. Our EBITDA generation is a big step-up from where it's been, and that's through a balanced growth of revenue and margin expansion. Our revenue growth primarily in the emerging markets over the next several years, and EBITDA margin expansion here in the more consolidated markets in North America. Greater than cost of capital returns and increasing our free cash flow enables us to, as we said, allocate that cash in a balanced manner through both reinvestment and return of capital to shareowners, and obviously you saw one of the steps of that in the announcement we made yesterday.

Just to share with you the timeline of where International Paper has been, we had a lot of portfolio moves back in 2005, 2006, 2007, and 2008 period that we called out our transformation plan, we all went into the deepest recession that we had in 60, 70 years in our lifetime, since 2008-2009, it seems like a distant memory. International Paper came out of that as a better, stronger company, and since the transformation plan now is in the rear-view mirror, and the focus within the Company is to generate results from those changes we made with a stronger and better International Paper. What you see on the bottom there are just some of the asset sales over the left the businesses we're no longer in, and then some of the reinvestments we've made along the way to build a stronger, better International Paper. So we're excited about the portfolio we have. We think we've got strong good positions in North America, the big mature markets, and we think we've got good positions in some of the emerging markets where there is growth, there are good EBITDA margins, and we see opportunities to selectively grow over time.

The real story about International Paper is its cash flow story, and this shows you our cash flow going back to 2005. In the 2007 period, we were averaging about $700 million a year. A big chunk of that was coming from land sales. We knew that was going to end, so we decided to end it quickly by selling the land, and as you can see, since the transformation plan has basically been completed, we've stepped up our capability to generate free cash flow on a smaller capital base which has enabled us to not only grow our free cash flow but to prove our returns on invested capital into the cost of capital range.

We talked about International Paper being a cash flow story, and then taking that cash and allocating it in a balanced way, and yesterday we announced a 17% increase in our dividend in the fourth quarter of this year to $1.40, and that moved us closer to our target dividend of 30% to 40% of free cash flow over the cycle, and what you see here is our free cash flow in the second quarter was about $1.8 billion annualized and $1.40 dividend puts us in the 30% range.

We also at the same time, consistent with that balanced use of cash with returning some of it to shareowners, announced a share repurchase which I think is, we did have a share repurchase [in our] program but part of our transformation plan. When we generated $11 billion of cash, we bought back $2.5 billion of stock, but we did it kind of in one transaction. That was generating a lot of cash. We think in addition to increasing the dividend, it's appropriate and we're capable of having a share buyback program as well. So, $1.5 billion over the next two to three years and we'll use open market purchase transactions to accomplish that and we'll get started with it as soon as we can get all the necessary paperwork put together.

The other big decision in the news was one that was -- we did not want to make, but concluded we have to make because it impacted a lot of hard-working, dedicated, long-term employees in International Paper, was that our Courtland, Alabama Printing Papers mill where we announced yesterday that we're going to close that mill over time, that should be closed by the middle of next year, because of what we see as a supply demand situation that we've known as – that we're in, in our own uncoated freesheet business in North America, shrinking about 3% to 4% a year, we knew we're going to have to adjust our footprint to match our supply with our demand, and after a lot of work concluded that the right place to do that, although it was a tough decision, is to do it at Courtland, Alabama.

So, the Printing Papers business, I think this is really important in the context of International Paper. At one point in time, the Printing Papers business in North America – because we're also in the business in Eastern Europe, in Russia, in Brazil and Latin America and in India – at one point in time, it was more than 20% of our EBITDA. It's now closer to 7% to 8% of our EBITDA at the Printing Papers business in North America. So it's a healthy business but it's a smaller and smaller part of International Paper. So, while I don't want to say it's not a needle mover, I think in the context of thinking about International Paper going forward, we've built an International Paper that's prepared to be successful and to grow our EBITDA even recognizing that our Printing Papers business in North America is in a market that's not growing any longer.

So, what are we going to have post Courtland? Two commodity mills, Eastover, South Carolina and some Alabama, both first quartile mills that produce the commodity grades of paper, and then two what I would call value adder or specialty mills, Georgetown, South Carolina which makes a whole range of products not just the commodity uncoated freesheet, and Ticonderoga which is really making grades of cut size that we can't make in our other facilities because of the more value-added end of the cut size spectrum. So a strong system, four facilities, and I think those four facilities are all low cost to the markets they serve. Ticonderoga on cost curve looks like it's serving a value-added segment. So, we like that footprint going forward.

So, let me just sum up with a slide that we showed you at the end of the second quarter. When we had our second quarter conference call, we were talking about the outlook. We said there are some tailwinds, but there are also some headwinds, and this is right out of the material that we showed you, and just let me update that for a minute of what's changed. We see frankly in the third quarter more headwinds, and I think the most significant one which is seasonal, and I don't want to sound like a farmer, it's too wet, it's too dry, it's too hot, it's too cold, but we're on track in the Southeast to have – and frankly none of us really saw this happening to the degree it has happened to having the wettest summer in the Southeast, the wettest year since 1895. I don't want to make you all almanac readers, but that's what it is. And that really started to happen at the end of May. We just had, and without a big tropical storm coming to the Southeast, we've had it from Virginia really right down to Florida and Alabama, we're on track to have the wettest weather season we've had in 100 years.

So what that meant is our wood cost, particularly hardwood, have continued – we forecasted that we were going to rise in the third quarter, they're going to rise, and have risen a lot more significantly than we had planned, and they have more than doubled kind of at the margin. So that's going to cost us, could cost us $20 million to $30 million over and above what we had thought it was going to cost us when we were talking about our outlook for the third quarter. That's not structural. It's seasonal. Eventually, it will dry out and you won't have to go as far away to get hardwood, but our inventories are coming down and at this point in time of the year, they should be going up.

Emerging markets, currencies have continued to get weaker and unbalanced. That helps us in some markets, hurts us in others, but on balance, it's slightly negative for us. And we've also seen a little less pulp improvement. Within the pulp price improvement, we expected it, but we are getting a little less than we thought. We basically thought we'll probably get $40 during the quarter, we're probably going to get $20. The good news is, the European markets I think have hit the bottom and are stabilizing. I was in Europe and Turkey about 10 days ago, and most of the people I talked to said the same thing I was reading and hearing, is not that Europe is turning the corner, but the economies, even in places like Italy, France, Germany, Spain, Portugal have probably hit the bottom, and some like Germany are turning up a bit.

So, how do we think about the outlook for the third quarter? It still is going to be a very strong quarter, probably at or near record levels. Excluding land sales, it was a very strong free cash flow generation, but a few more headwinds in the third quarter than we had seen when we talked to you last.

So just getting to look beyond the third quarter, what's International Paper's potential? When we had our last Investor Day, May of last year, we told you that mid-cycle we thought the current portfolio is capable of generating over $5 billion EBITDA and a return on capital well above our cost of capital with free cash flow in excess of $2 billion. That's still where we see International Paper going, and we think we're well on our way to getting there. It's going to happen as it always does differently than we thought. Some businesses we're going to do better, some businesses are going to have more headwinds than we thought, but on balance, and I think the important part of International Paper is, we have enough balance and enough diversity while still being focused to offset the headwinds with some of the tailwinds that we're creating inside the Company.

So, just what do we see as the strategic drivers of earnings being going forward, and this is my last slide, certainly the transformation plan kept it off but where we are right now is what I've called in the middle in the near term bucket, optimizing our new Industrial Packaging business which eight years ago was a $4 billion business, now it's a $12 billion business. We've gone through two big integrations with Weyerhaeuser and with Temple, but now we're off to optimizing, which is very different than integrating, a $12 billion business, and we see as much optimization value, which is market expansion opportunity in optimizing the business as we saw in integrating Temple, which means $400 million to $500 million over the next several years.

Our Printing Papers business will have a better cost position and better margins with its new footprint. The Ilim projects, which don't flow in the EBITDA, are completed. That's in a joint venture in Russia, and now ramping up. We see a huge opportunity to reduce costs, expand our volume into a market we serve on a low cost basis which is China, and that's going to create a lot more dividend potential, which is cash back to International Paper. And then in the emerging markets, over time we see in places like Latin America, again Russia, and in India, although India is still small, the opportunity to profitably grow our business with the businesses we have, and possibly places like India get into packaging. So, I think International Paper is well set up for going into 2014 which is our near-term horizon, but importantly we see opportunities to further improve our free cash flow generation over time with the portfolio we have.

So I'll stop right there and how much time we have for questions, Gail?

Question-and-Answer Session

Gail Glazerman - UBS

15 minutes. I'm going to kick it off but you can also help me out.

John V. Faraci

Okay, you'll be the timekeeper?

Gail Glazerman - UBS

If anybody in the room has a question, we'll get to you just as I am going to kick it off. John, can you talk a little bit, you talked about Europe, but can you talk to more broadly what you're seeing in the demand environment in terms of a couple of specifics for both products, in terms of boxes, coated paperboard, uncoated freesheets, but also talk about maybe some of the geographies, China, India at all?

John V. Faraci

In Europe?

Gail Glazerman - UBS

No, no. You kind of touched on, I believe, the overall trends in Europe, I'm just wondering can you talk to, one, I guess about your cost demand, maybe coated paperboards as well as uncoated freesheets just what you're seeing in the last month or two, and then talk a little bit about I guess China and Brazil and India?

John V. Faraci

I think in aggregate, top line – the quick response to that is box volume is up by about 0.5% to 1% for the industry. It feels like 1.5% and 2% GDP growth because box volume really, it is probably GDP growth less 1% in North America. The Printing Papers business is, we think is declining at 3% to 4% in North America, although August was one of the stronger months we have had in terms of shipments, but I think that's just probably seasonal and maybe that’s picking up a little business with some customers who are doing better. Coated paperboard frankly is better than we thought it would be. That business got hit pretty hard in 2012 on the volume side. The first quarter was very tough for us. That was the low watermark. But we told you at the end of the second quarter we're going to have a much stronger third quarter in coated paperboard and it's playing out that way. Shipments are up for us about 3% year-on-year.

Latin America, we're in a good position. We serve the whole Latin America market out of Brazil, we have a significant market position there, and our volume in Latin America is up 8% year-over-year. So that's good. Corrugated packaging, volume is growing in this business, volume is up by 3% in corrugated packaging business in Brazil. OCC prices were also high, so we got a bit of a margin squeeze, but I'd say looking at paper demand, we're growing faster than the market in Latin America, no question about it, because the market is not growing at 8%, the market's really growing at 2% or 3%.

In Europe, we're tilted in paper to the East Russia and Poland. Russia is growing at about 3% in uncoated freesheet, we're out of capacity which is the reason the Ilim joint venture has completed the addition of a new paper machine that will serve the Russian and Eastern European market. So our paper business in Europe is doing quite well. That's also coated board at our facility that we make in Poland. The box business in Southern Europe, this is frantically [indiscernible], it's down about 3% year-over-year. And Turkey and Morocco which are the other places that we are in that part of the world, volume growth is quite good.

China, the markets are growing but they are growing at a slower rate and there's a lot of excess capacity. It doesn't matter whether it's paper or cement or steel, there's a lot of excess capacity in the commodity businesses in China and we're just going to have to work through that. So when I read, people say the emerging markets are growing but slowing and the developed markets are growing much slower than their potential, that looks like what we see when we look around the world of International Paper.

Gail Glazerman - UBS

So one more and then we'll come back there, in terms of the Courtland shut, is there any guidance you can give us in terms of some of the financial impacts of that? I acknowledge domestic Printing Papers is a fairly small part of the whole but if there's anything you can think of on how we should think of the consequences of that?

John V. Faraci

It's going to cost us less than $50 million over time after tax to complete the closure. So that's not all a one-shot deal. It will be a significant non-cash asset write-off that occurs probably next year associated with this. But I think the important part thinking about Printing Papers, and then I'll put Courtland in context, Printing Papers' North American total is less than 10% of our EBITDA and our EBITDA is going up. So in 2014, I think it will probably be closer to 5% and 10%.

Courtland if you take, is the least profitable volume we make in our system and there is a tail of very good business to not-so-good business. And when we rebalance our capacity, what we're making, where we're selling it, the least profitable business will come out. So the margin should improve, there will be lower volume, but I suspect Courtland's percentage, their EBITDA percentage of International Paper is probably 1%. We don't do mill P&Ls but if the whole North America Printing Papers business is 7% or 8%, Courtland is probably closer to 1%, maybe 2%.

So it really is not a needle mover and it's not material in terms of its cash contribution to International Paper, especially if you look at it after CapEx. We've been spending about $30 million a year there on average. Looking backwards, if we continue to operate Courtland, we are required to spend more than that, but the reason for making that decision was not about a future investment, it was about the fact that when we looked at our footprint, we have more capacity than we had demand.

Gail Glazerman - UBS

Okay.

John V. Faraci

And we want to stay in front of the curve, not get behind the curve, just like we did with Franklin. Franklin was a big facility, it was a tough decision to make, a lot of employees, a small town, all the things we really cared about at International Paper, but it was the right thing to do at the time.

Unidentified Participant

So is the transformation complete or are we there focused more towards acquisition?

John V. Faraci

No, it's complete. We've got the portfolio that we like. I mean obviously we're going to keep on looking at our strategy. The world is changing, International Paper is going to change, but we are out of the transformation plan and now delivering results on what we've put in place post that. So we're not looking at big acquisitions. I think in North America most of our markets, we've got good positions and probably have – would have antitrust issues with anything going further, certainly in containerboard we would.

Gail Glazerman - UBS

John, can you give an update on the xpedx process?

John V. Faraci

Sure. We knew it was going to take some time, and we were right, it's going to take some time. We announced a letter of intent that we had signed with Unisource which was owned by Bain Capital back in April because we wanted to accelerate the work that needed to be done. And think of this as two private companies merging and going public, one owned by private equity company, one is owned by International Paper. So we had to get audited financial statements for xpedx which we hadn't had. xpedx was a complicated business location.

We knew that would take six months, it did take six months, they are completed now. Bain has those and so the letter of intent framed an outline of a transaction that both Bain and International Paper thought will be beneficial to both companies, and assuming that outline holds together, we'll be finishing up the work we need to do to get to the finish line probably before the end, in the fourth quarter, with a close probably to happen in the first quarter, but until we have a deal – we don't have a deal.

Remember Bain approached us with a transaction they thought made sense for them, we thought it could make sense to us, it's not something we have to do, and if it's attractive to International Paper, we will do it. We think it could be very attractive to both International Paper and International Paper's shareholders. So we've got the antitrust clearance to go ahead, we've got the audits behind us, we're in the process of getting ready to file registration statements which both Unisource and xpedx will have to do, we're going through organizational design, recruiting Board members, all the stuff you have to do, so there's lots of work.

Unidentified Participant

Should process with Bain not reach the finish line, would an alternative of xpedx going out, given all the work that's been done, that it will start to make sense?

John V. Faraci

I don't want to speculate on that but I would say that until – the reason we got interested in the transaction that Bain came to us was, as we've said, this is something that can create value for both xpedx and Unisource, so neither xpedx or Unisource can do by himself, and I think it's somewhat unique because of the businesses the two companies are in and their scale. So absent a combination like that, there is some value that won't get created, certainly xpedx couldn't do it on their own. So our plan until we got approached by Bain was to run xpedx. We thought we had a good plan in place to improve the business. It is 80%, what it does is paper and packaging distribution, it's had some challenges because of what's going on in commercial print, we recognize those, Bain has got the same challenges. So I'd say our alternative right now is we do this transaction because we think it's better than running the business or re-run the business.

Gail Glazerman - UBS

Are there any other parts of the portfolio that – and you had a plan to improve xpedx, you weren't making a lot of progress there, are there any other parts of the portfolio that would be trouble spots that you think you need to fix at this point or do you think they are all pretty much valid kind of returning cost of capital parts of IP?

John V. Faraci

I think they are all – not I think, we think, that every part of the Company now is either at or has got credible doable plans to get the cost of capital returns, and that's our objective at International Paper. In some places in the world like India we're in the beginning of getting into the business, and so we realize that those plans have a longer time frame than our plans for coated paperboard or industrial packaging or printing papers in North America, but we're in a different business over there, we're putting assets in the ground to grow the business. In North America, we're consolidating, taking costs out, competing in a different kind of market.

So I don't see – the good news about International Paper is we're not sitting back. So I mean the only way we're going to get better is that volume growth and prices go up. We've got good internal programs to expand our margins because we're doing different things. I mean take industrial packaging which is our [indiscernible] carrier of the Company, we've now got a $12 billion business that's never been optimized. None of our competitors have that kind of margin expansion opportunity, we do. So we're going to benefit if the world economies get better and I believe eventually they will, we'll benefit if prices go up, we'll benefit but so will everybody else. So we've got some things that we can do that I think enable us to add to our margins even if volume and prices stay the same.

Gail Glazerman - UBS

And in terms of the wood cost inflation, are you seeing signs of that levelling out or is it still getting worse, or are you seeing any…?

John V. Faraci

The seasonal stuff I talked about is getting worse. What's happening is it's still raining. I mean if we're going to have the wettest summer in the Southeast since 1895, I don't know how many inches that is but it's got to be a lot. I just remember someone calling me over the summer and saying in Wilmington, North Carolina which is where our Riegelwood facility is, we've had 21 inches of rain in 30 days or something. But that's transitory. I mean it's not going to take four years for that or three years or 36 months for that to correct itself.

We'll have to go through – if we go into the wintertime with tight inventories, wood cost will be high, it will be high for everybody that's in that part of the world, from Virginia down through Florida, Alberta, Alabama, but then we'll get into next year buyout, we'll shrink, the drain areas and the wood cost will come down. When we have a dry winter we get the advantage, when we have a wet fall and winter we get hit.

Unidentified Participant

The transformation you mentioned is complete, you don't have to optimize portfolio, what you have now, you're generating a lot of free cash flow, you're starting to use about the first of getting money back to the shareholders and so on, are you comfortable with where your leverage is right now, roughly in the 2.5 times?

John V. Faraci

We are.

Unidentified Participant

Or would you go higher, would you want to take that lower?

John V. Faraci

No, we told the rating agencies and they kind of agree to this that a debt-to-EBITDA coverage ratio of 3 or less is where we want to be. No, we're not out to – we really have a stronger credit rating than we normally have. So we don't want to be under-leveraged but we don't want to be over-leveraged. We want to be flexible to be able to do the kinds of things that might make International Paper better and stronger if they come up, and what's happening is as our EBITDA grows, our debt-to-equity impact is improving.

And when we look at our debt maturities, it doesn't make sense for us to go pay $1.30 to buy back $1 worth of debt in today's environment, and we have big refinance, we have some debt maturities coming due in 2017 and 2018, but at this point in time, we'll just plan on refinancing those because we've got plenty of capability to carry the amount of debt we have. Most of our debt repayment is going to go, I think they're going to pension plan, and a placeholder of $1 billion, $1.5 billion over the next couple of years to fund the pension plan. On an accounting basis, every 100 basis points of interest rate increase is a $1.5 billion less pension liabilities. So we're still going to have to put cash into it and have planned to do that.

Unidentified Participant

As liability comes down, does that affect the [indiscernible] expense, non-cash it does but that's 100 basis points [indiscernible]?

John V. Faraci

Sure. Michele and I don't have that off the top of my head but we can get it to you, but we don't really – it's not like I'm thinking about that because while it does help EPS, it's not cash.

Gail Glazerman - UBS

With that actually we're a little bit over, but John thank you very much.

John V. Faraci

Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: International Paper's CEO Presents at 2013 UBS Global Paper and Packaging Forum (Transcript)
This Transcript
All Transcripts