Q3 2021 International Paper Co Earnings Call
Okay.
Good morning, and thank you for standing by welcome to today's international paper third quarter 2021 earnings conference call all.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and.
Answer session.
Ask a question. Please press star one on your telephone keypad.
To withdraw your question press the pound key.
I would now like to turn the conference over to Guillermo Gutierrez, Vice President Investor Relations. Please go ahead Sir.
Thank you Angie good morning, and thank you for joining international paper's third quarter 2021 earnings call. Our speakers. This morning are Mark Sutton, Chairman and Chief Executive Officer, and Tim Nicholls Senior Vice President and Chief Financial Officer. There is important information at the beginning our presentation.
On slide two including certain legal disclaimers for example during.
On today's call, we will make forward looking statements that are subject to risks and uncertainties.
We will also present certain non U S GAAP financial information.
A reconciliation of those figures to U S. GAAP financial measures is available on our website.
Our website also contains copies of the third quarter 2021 earnings press release and today's presentation slides.
Lastly, relative to the old joint venture Slide two provides context around the joint Venture's financial information and statistical measures.
I'll now turn the call over to Mark Sutton.
Thank you Dan and good morning, everyone.
I'll begin our discussion on slide three.
In the third quarter International paper revenue earnings and margins and we continued to generate strong cash from operations.
We continue to see strong demand for corrugated packaging and solid demand for absorbent pulp.
We're making strong progress on price realization from our prior increases.
Having said that our supply chain and input cost environment remains very challenging and it impacted our results much more than we anticipated.
The widespread supply chain constraints limited our ability to capture the full opportunity that comes with a strong level of demand that we're seeing.
Our mills performed well, however stretch supply chain impacted volume in our industrial packaging and global cellulose fibers businesses.
Containerboard inventories and our packaging network improved in the latter part of the third quarter and we are in a much better position as we enter the seasonally strong fourth quarter.
Input costs in the third quarter rose by about $230 million or <unk> 46 per share.
Which was more than two times, what we had anticipated with cost pressure in just about every category.
Our <unk> joint venture delivered another strong performance with equity equity earnings of $95 million.
On capital allocation, we continue to make significant progress strengthening our balance sheet.
In the third quarter, we reduced debt by $235 million.
I would also highlight that our pension plan is fully funded.
This is a significant milestone that further strengthens the company.
In the third quarter, we also returned $411 million true to our shareowners, including $212 million of share repurchases.
On October one we completed the spin off of the printing papers business.
<unk> received a $1 4 billion payment from Silvana and we retained a 19, 9% interest in the new company, which we intend to monetize within one year.
The team has done an outstanding job executing a transaction in a very challenging environment.
Paper's business delivered a strong performance in the third quarter and we wish Obama all the best as they move forward as a Standalone company we are.
Our laser focus on strengthening the company and building a better IP for all of our stakeholders.
Tim and I will share more about the progress we're making.
During today's discussion.
Turning now to slide four.
We delivered EBITDA of $938 million in free cash flow of $519 million in the third quarter, which brings our free cash flow of nearly $1 6 billion year to date.
Revenue increased by nearly 600 million or 12% when compared to last year.
And if we exclude the printing papers business third quarter revenue grew by 14% as compared to last year.
We also expanded our margins in the third quarter with realization of our prior price increases.
We expect continued margin expansion in the fourth quarter.
I will now turn it over to Tim who will cover our business performance and our fourth fourth quarter outlook.
Tim.
Thanks, Mark moving to the quarter over quarter earnings Bridge on slide five third quarter operating earnings per share were $1 35.
Compared to $1.06 in the second quarter.
Price and mix improved by 43 per share with strong price realization across the three businesses.
<unk> decreased sequentially.
Supply chain constraints limited our ability to capture the full benefit of the strong demand backdrop.
We replenished our containerboard inventories in the latter part of the third quarter, which positions us well entering the seasonally strong fourth quarter.
In our cellulose fibers business demand for absorbent pulp is solid.
Pulp shipments were constrained due to significant port congestion and backlogs remained stretched.
Our mills performed well.
Operating cost benefited by about $35 million of one time items, including the cell nitrogen credits and insurance recovery related to the winter storms earlier this year.
Supply chain stretched and transportation costs are elevated for both inbound materials and outbound shipments.
Every mode of transportation is tight and we expect the transportation environment to remain tight for the foreseeable future.
Maintenance costs decreased as expected.
<unk> cost rose by 46 per share or about $230 million.
Which is more than double what we had anticipated for the quarter.
Higher fiber and energy cost accounted for about 80% of this increase.
Corporate expenses were essentially flat tax expense was lower by four cents per share in the third quarter with an effective tax rate of 18% as compared to 21% in the second quarter.
Most of this was related to adjustments to our federal tax provision after finalizing our 2020 tax return in the third quarter.
Equity earnings were lower sequentially. Following the final monetization of our stake in <unk> in the second quarter.
Turning to the segments I'll start with industrial packaging on slide six.
We're seeing strong demand across all channels, including boxes sheets and containerboard third.
Third quarter shipment across our U S channels improved by one 3% year over year. However.
However box shipments were hampered by low containerboard inventories and strikes supply chains.
We successfully replenished inventories across our boxes.
Some in the latter part of the third quarter, which puts us in a much better inventory position as we enter the seasonally strong fourth quarter.
We expect supply chain to remain stretch for the foreseeable future, which requires us to carry more inventory given the slower velocity across our network.
To put the velocity into context, our mills to box plant containerboard supply chain is currently running three to four days longer than our normalized flow and then some lanes even longer.
Taking a look at third quarter performance price and mix was strong.
Our March increase is essentially fully implemented with $128 million of price realization in the third quarter.
Sure.
Volume was lower by $45 million box shipments in North America were impacted by low containerboard inventory, especially in the first half of the quarter.
Volume in EMEA was seasonally slower as expected representing about $10 million of the sequential decrease.
Operations and costs were essentially flat sequentially.
Our mill system performed at a 100% and provided much needed inventory related to our box system in the third quarter. We also received insurance proceeds of about $15 million related to the winter storm.
These benefits were largely offset by unplanned maintenance cost.
We're not seeing any relief on supply chain costs.
And are managing risk associated with transportation capacity and congestion across the rail and truck networks.
Input costs increased by nearly $190 million in the quarter OCC and wood fiber accounted for.
$20 million of that total.
Energy accounted for another $45 million, primarily in our recycled containerboard mills and our box plants.
Taking a closer look at fiber, our north American packaging fiber mix is around 65% Virgin wood and 35% OCC.
Wood fiber costs rose sharply in the third quarter due to continued wet conditions across the southern and eastern regions as well as inbound transportation constraints.
Wood inventories are below our control limits and we expect difficult operating conditions again in the fourth quarter.
We expect demand for OCC to remains strong.
With no cost relief, even as generation gradually improves as a reminder, we consume about $4 5 million tons annually in the U S and nearly a half million tons in EMEA.
Moving to global cellulose fibers on slide seven the business delivered earnings of $96 million.
Third quarter segment earnings included $13 million from this of almost subsidiary and liquids and mill, which are no longer part of our operations in the fourth quarter.
Looking at our sequential earnings price and mix improved by $59 million.
Volume improved by $11 million sequentially.
Demand for fluff pulp, which represents about 75 of our 75% of our mix remains solid.
Our shipments continue to be negatively impacted by unprecedented port congestion and vessel delays.
Keep in mind that we explored about 90% of our volume in this business.
The majority of this is fluff pulp that ships and containers.
Which is where port congestion is especially challenging.
We have systems in place to manage through this environment. However.
Vessel delays and higher supply chain costs are expected to continue for the foreseeable future.
Our mills performed well, we also benefited from about $20 million of one time items related to the sale of nitrogen credits and lower corporate costs in the quarter.
These benefits were largely offset by $50 million of higher supply chain costs for export operations.
Maintenance outage costs decreased sequentially, while input costs were a significant headwind in the third quarter, driven primarily by higher wood and chemical costs.
Yes.
Turning to printing papers on slide eight the business delivered earnings of 106 million in the third quarter with strong momentum ahead of the spin off third quarter results included the Queensland mill until the sell on August six.
<unk> in the third quarter was strong with continued demand recovery globally and price realization outpacing rising input costs.
Now that the spin off is complete the historical results of the business will be treated as a discontinued operation with a full recast of previous periods.
And going forward activity pertaining to the printing papers offtake agreement, where Riverdale Georgetown.
It will be included in our packaging and global cellulose fiber segment earnings.
I do want to echo Mark's sentiment and thank our teams for success of successfully executing the spin and a very challenging environment.
Looking to the results on slide nine.
The joint venture delivered another quarter of strong performance with equity earnings of $95 million and an EBITDA margin of 44%.
Solid price realizations for pulp and containerboard were partially offset by lower volume due to high planned maintenance outages in the quarter as expected.
Volume in the fourth quarter is expected to improve however, shipping capacity remains tight and supply chain to China are stretched.
So now I will turn to the fourth quarter outlook on slide 10.
In industrial packaging, we expect price and mix to improve by $70 million, mostly on the realization of our August 2021 price increase.
That includes a negative mix impact as we start to recover some export backlogs.
Volume is expected to improve by $65 million sequentially on strong seasonal demand, even as we sat down three shipping days.
Operations and costs are expected to improve by $5 million with the North American system benefiting from improved.
<unk> inventory levels.
We offset by onetime benefits in the third quarter.
Staying with industrial packaging.
Maintenance outage expense is expected to increase by $3 million.
<unk> costs are expected to increase by $50 million, mostly on the flow through of higher third quarter input costs for fiber and energy.
In global cellulose fibers, we expect price and mix to be stable vol.
Volume is expected to decrease by $5 million.
Operations and costs are expected to decrease earnings by $25 million due to the non repeat of one time benefits in the third quarter.
Maintenance outage expense is expected to increase by $37 million and input costs are expected to increase by $15 million on higher wood and energy costs.
On our outlook Slide we include the sequential earnings adjustment associated with the printing papers spin and Quintan sell for a total of $134 million across the three segments.
With regard to cash flow I would note that our cash from operations in the second half of 2021 includes cash taxes of about $450 million associated with the various monetization transactions from earlier this year.
Remember that the proceeds from these transactions are not captured in our free cash flow. However, the resulting cash taxes are included in free cash flow and the majority will be paid in the fourth quarter.
Turning to slide 11, I'll take a moment to update you on our capital allocation actions actions in the third quarter and what you can expect from international paper following the recent papers.
We will maintain a strong balance sheet as we've previously said, we're comfortable taking our leverage below the stated target of two and a half to two eight times debt to EBITDA on a moody's basis.
In the third quarter, we reduced debt by $235 million, which brings our year to date debt reduction to $1 1 billion.
We will also we will also complete an additional $800 million of debt repayment by the end of this month.
Taking a look at pension we're very pleased with the performance of our plan. This year our requirement pension plan is fully funded.
And we feel really good about the actions we've taken to improve performance and Derisked the plan.
Returning cash to shareowners as a meaningful part of our capital allocation framework in the third quarter, we returned $411 million to shareholders through dividends and share repurchases.
Share repurchases were $212 million, which represented about three 6 million shares at an average price of $59 13.
Also earlier this month the board of directors approved an additional $2 billion share repurchase program, which raises our total available authorization to $3 3 billion we.
We will continue to execute execute on that authorization in a manner that maximizes value for shareowners over time.
With regard to the dividend our policy does not change.
We are committed to a competitive and sustainable dividend with a payout of 40% to 50% of free cash flow, which.
We will continue to review annually as earnings and cash flow growth.
Earlier this month, we decreased our dividend by nine 8% to $1 85 per share annually.
Following the spin off of the papers business this adjustment as well below the 15% to 20% proportion of cash previously generated by the papers business as we outlined when we announced the spin last year.
Investment excellence is essential to growing earnings and cash generation, we expect capex in 2021 to be around $600 million, which is less than our original plan, primarily due to the timing of equipment delivery and a more challenging contract labor environment.
We will continue to proactively manage capex and have the ability to increase or comes back if circumstances warrant.
You can expect strategic capital to be deployed mostly to our packaging business to build up capability and capacity needs to drive profitable growth.
We will continue to assess discipline and selective M&A opportunities to supplement our goal of accelerating profitable growth.
You can expect M&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 value for our shareholders that.
I'll turn it back over tomorrow.
Sure.
Thanks, Tim for all the details.
Im on slide 12, now, let's talk about the future and how we're going to accelerate value creation for IP and our shareowners. We are building a better IP at the recent spinoff of the papers business IP is really a corrugated packaging focused company.
We are significantly less complex with a much narrower geographic footprint.
In addition, we have strengthened the company's financial flooding as Tom has described significantly over the past few years, our focus profile and financial strength will further enable us to make sustainable.
<unk> profitable growth.
Salary value creation.
As I said earlier in the process.
We've been actively working on multiple streams of earnings initiatives over the past year.
We established a dedicated team that's been working closely with our businesses and external partners over the past year to identify develop and pilot a wide range of highly attractive opportunities, which are now moving to scaled implementation.
Turn to slide 13 to see how our earnings drivers ramp up over the next few years.
We will deliver $200 million to $225 million of gross incremental earnings in 2022 that represents more than two times, the dis synergies, resulting from the spin off.
Our value drivers ramp up in 'twenty, three and 2024 with net incremental earnings of $350 million to $400 million.
<unk> 2020 for these.
These include around $300 million and cost reduction initiatives at least $50 million through commercial and investment initiatives.
Our earnings catalysts are frontloaded with significant benefits coming in 2022 from streamlining and simplifying the company and scaling a wide range of process optimization initiatives.
Streamlining and simplifying its all about agility and effectiveness. The organization is being designed to support a packaging focused company with a more focused footprint, we are aligning our talent to accelerate performance.
We've also examined our processes to increase efficiency and reduce cost.
We're implementing and scaling new approaches for areas such as sourcing.
<unk> chain and operations by leveraging technology and data analytics and to give you a few examples of these value drivers for 2022.
We redesigned our sourcing process for our 200 converting facilities.
Using data analytics and third party partners to deploy an automated catalog of sourcing options for operating and repair materials in our box plants.
Program will deliver meaningful value in 2022.
We're also using data analytics to unlock capacity in our converting facilities by improving our planning and our execution process. This includes for example, how we aggregate and planned smaller orders and how we can optimize our manufacturing mix in each plant and each network of plants.
We've also developed a new application to further optimize containerboard replenishment to our box plants.
Assistant anticipates potential roll inventory stock outs, which had been a big issue for us this year and recommend to the lowest cost replenishment option to reduce premium freight.
There are many initiatives that contribute to our value drivers and the savings we have really good line of sight on the expected benefits in 2022 and.
And to wrap up as we move forward.
Our 2022 value drivers not only deliver meaningful benefits in the near term.
We're also setting the foundation for IP going forward.
To accelerate commercial and investment excellence to drive profitable growth.
So with that we're ready to take your questions.
Yes.
As a reminder to ask a question. Please press star one on your telephone.
Yes.
I can ask a question please press star one.
We'll pause for a moment to compile the Q&A roster.
Yes.
Your first question comes from the line of Phil <unk> with Jefferies.
Hey, guys.
It's been a challenging few quarters.
Despite a pretty healthy demand backdrop.
Inventory normalizing for you guys in pricing flowing through when do you actually expect EBIT margin and EBIT dollar to be up year over year industrial and.
And now that you have.
Inventory at a more respectable level do you expect your box shipments to track more in line with the broad administered in the fourth quarter.
That's a great question, Phil what we talked about on our second quarter as we thought it would take at least till the end of the year to get the inventory situation, where it wasn't constrained I think we made a little more progress than we expected in the third quarter and most importantly.
September was a lot better than July.
But we still have some spotty issues, depending on the grade and the type of end use box, but we see as we enter into the fourth quarter with the progress we made in the third quarter, we should be getting close to our ability from a board supply to <unk>.
Track, our own box shipments with the market and we will continue to see EBITDA margin in absolute EBITDA improvement as we go forward as you know and as we outlined and Tim talked about.
We got it wrong on a number of our cost initiatives and our outlook for the fourth for the third quarter.
That obviously took a bite out of our EBITDA margins, we really expect it to be EBITDA margins in the Twentyish plus percent in the third quarter and we didn't get there primarily on the back of some costs that whereas I said in some cases twice as much as we thought they would be some of those costs off OCC or our own estimates about supply.
Man in generation, and where we're going to buy it from and what the transportation component is and some of those costs are simply public information that I think all investors use like the natural gas strip and things that are kind of publicly available.
And in a big way and we start all got it wrong on that.
I'm encouraged that we're making progress.
We're going to get the.
As we mentioned.
This flow through is going well and we're going to see our margins expand and we are positioning the company to have no reason why we can't grow and box and in our other channels, which we've had a lot of success board that goes whether it's to our equity partners or whether it's pure open market and that goes into the U S box business as well.
That overall three channel approach, we're doing quite well our own box plants have suffered primarily from the ability of us to get the right containerboard into the right plant at the right time. It May show up two weeks eight and the order has to be made two weeks earlier. So that's in a lot better shape and I feel good about that right now.
Got it that's helpful.
As a school of thought I mean, a lot of people have got four weeks of inventories about balance, but appreciating. The challenge is the entire industry, you're seeing on from a supply chain.
What's what's balance for you because when we looked at the inventory data from the <unk> data it really perked up a bit.
<unk>.
Alarms, but given some of the supply chain dynamics.
Help us understand what's a good level in this backdrop.
Yes, Hey, Phil it's Tim So right now I think that we've mentioned in some of the comments.
As we went through the slides.
We are three to four days longer.
Slower in terms of velocity to get board from the mill to the box plants than what we would be at a more normalized type of environment. So just think about the size of our system. That's that's a pretty big numbers.
Number just to make sure that board is arriving in time to be consumed four four box customers.
The net of Tim's comments is we don't know is that three to four days is going to go to five it depends on velocity through trucking and rail primarily for containerboard.
Ports are more of an issue for cellulose fibers, but planning for that.
One two and three months out is what we're doing now and I think youre going to probably see for IP I know inventory above our normal historical is a good investment right now because it leads almost automatically to a sale of a box.
Got it that's helpful and just one last one for me.
Certainly generate a lot of cash you've announced a sizable buyback program and have about 3 billion buyback available.
Color on the pace and more youll look to used vehicles like ours.
And just broadly how do you kind of plan on deploying some of that excess cash on your balance sheet in the near term.
Yes. Good question, so I think.
The summary comment would be we have not changed the framework of how we think about capital allocation and deployment.
We've done a lot to try to Derisk the company through balance sheet and pension as I mentioned in the comments our qualified plans now.
<unk> fully funded.
And.
It's been a long time since we've been in that position, so going a little bit lower on leverage is something we've been pointing to for probably more than a year now on share repurchases.
We are the good news is we have the added authorization to work with.
Going to constantly be looking at how we're trading versus our view of intrinsic value and we will modulate as we go through in time based on that view.
I think the thing I would add to Tim's comments, Phil on the capital allocation piece, we've never been in recent memory are even distant memory and the position. We are in today relative to our balance sheet, the cash generation and the ability to really consistently move cash through all elements of our value creation.
Asian framework. So we're committed to the dividend I think investors and everyone that follows us knows that share repurchases had been spotty. We're in a position now to have that be consistent as Tim said based on our view of intrinsic value and how we think about trying our best to do that as smartly as we can but it will be consistent and then.
On the investment in our own business.
Vesting and our current cash flow, meaning our current facilities investing in cost reduction and investing in.
Smart growth, which tends to be in our system bolt on type of growth. That's really what we're planning on doing and we're in a position for the first time in a long time to be able actually do that and do that well and do it consistently.
That's great color.
Great to have all of that Optionality really appreciate it. Thank you.
Your next question comes from the line of Anthony Pettinari with Citigroup.
Hi, good morning.
Yes.
The detail on the value creation initiatives is really helpful and.
There is a reference on the slide to meaningful improvements in global cellulose fibers performance and I'm. Just wondering if you could talk maybe broadly about the drivers to improve that performance.
Then we've seen other paper packaging companies were the benefits from some of these large initiatives maybe ultimately get competed away I'm. Just wondering if you could talk about your confidence that youll see this fully fall to the bottom line.
Our plan, obviously is to not let them get competed away some of some of the initiatives are we believe a bit unique to our.
Scale and footprint and it's going to be our job not to let them get competed away.
On the cellulose fibers question. Specifically this is an ongoing story of improvement in the way the business operates the way the business goes to market and as I mentioned I think two quarters ago, we should expect a steady quarter by quarter improvement in the performance of the business and we're seeing that we're seeing that.
Despite some of the unforeseen supply chain issues, which don't worry me so much strategically because I don't believe that'll be a permanent state of port velocities and all of those kinds of things. So I think we will have a much better business commercially on the customer mix the pricing strategies the contract mechanisms and as I mentioned.
And a couple of quarters ago, that's a multiple quarter process and I said, we should see quarterly checking points like we're doing today, we should see continued improvement and we had a really strong third quarter and so I think we'll continue to see that.
That supply chain will normalized no one knows for sure when maybe second half of next year I don't know.
But.
Running of the business for the long term with the right customers and the right commercial arrangements will continue to produce long term improvement in the business.
And so the value drivers I outlined that are in the data analytics category a lot of that has to do with international paper specific initiatives. There are other initiatives that are maybe more generic.
That are in the plan and then we're scaling.
We feel real confident that this is an opportunity for us to step up our earnings.
Okay, that's very helpful.
And then just maybe staying on cellulose fibers China's implemented this dual control policy, which I think is shut down a lot of capacity, maybe including some converters that are buying pulp.
But it's sort of hard for us to fully gauge what's going on on the ground can you just remind us the percentage of your cellulose fibers sales that are going to China.
And then the impact if any from the stool control policy. It seems like fluff prices have actually shown a fair amount of stability. So just wondering any comments there.
So the.
Yes.
Rough percentage of our fluff that goes to China is in that 30 ish percent range. So that's about a third of our our absorbent products goes there.
And we have a really I mean, the majority of that 30% is premium customers and converters.
And so we haven't seen a major impact from those issues.
Some of those that are affected more or smaller.
Call it the Chinese only companies that multinationals and the benefit of dealing with a multinational value chain is that you have predictable customers who get.
We have the wherewithal to navigate those things the challenges, it's large buyers with sophisticated purchasing procedures and contracts, but we like the customers we have especially given some of these things that are going on.
Okay. That's very helpful I'll turn it over.
Your next question comes from the line of Mark <unk> with bank of Montreal.
Thanks, Good morning, Mark Good morning, Tim.
Good morning.
Yes, Mark I wondered if you could just help us unpack the cost pressures.
In industrial packaging, but maybe a little more detail and maybe segue.
Segment, it between kind of North America, and Europe. It looks like if we go back through your last four quarterly bridges that your cost in industrial packaging were up approximately.
Hunter.
Over the last four quarters, so maybe just a little more detail around that.
Yes, I mean between the U S or North America, and Europe, just given the scale of the business. Most of it is going to be in North America and really it's.
It's been the exposure to.
OCC energy and chemicals, I mean, more recently wood, but the longer term stories.
Before the would impact in the third quarter.
It was really around OCC.
And energy costs, primarily natural gas.
So and it's moved rapidly and so I think that's what you're pointing out on your cost per ton number and just trying to keep up with that with price. So.
Year over year, we're a little bit ahead of their own price.
Our opportunity now as we're implementing this current price increase that margins can expand beyond what the input cost have have done most recently.
How much of that cost increase would you say is at the converting level.
If you just looked at your kind of cost per thousand or per tonne in the box business. We think about labor or do you think about transportation do you think about all of those inputs how much with those costs.
Yes, I mean, we don't break it out like that but there is an impact a lot of it goes to the mills just thinking about the inputs mentioned in their consumption, but in the box and the box system. You have materials that are unique to converting think about wax and other things, where we have seen price escalation also.
We're seeing higher labor cost kind of across all of our businesses and converting as it is impacted there as well so.
More on the mill side, and converting but converting for for the cost structure that the converting plants have its not immaterial.
Thank you.
Youre converting question Mark that unique thing thats happening in converting given the demand is on the labor side.
Our employees are showing up every day and done a fabulous job through this entire pandemic in some cases, we had plants that were designed pre pandemic to run five days, a week, which is not uncommon in the box industry somewhere 24, seven but not a lot of them.
<unk> had to ramp up over time and our employees have has accepted the challenge while we try to hire permanent employees, which has just been a real challenge in certain parts of the country. So that elevates a big portion of converting cost is labor. Unlike in our mill system, where the cost tend to be the inputs and then transportation.
Has been a real a real challenge and again some of it's regional.
But I think those.
Cost increases on the labor side, whether it's overtime with new employees.
Still the right thing to do because it allows us to get more revenue and more sales.
Yes, and I guess for follow on I'm, just curious mark it's been a while since we talked about kind of the ownership.
A few years ago, there was a lot of debate about whether it makes sense to have a bigger stake and to be able to consolidate the EBITDA.
Also conscious that you've got kind of a single partner on the other side you may.
It may have some estate planning to do can you just help us think.
The.
Ownership structure.
For going forward.
We.
We get that question either on calls or in meetings and our answer is we like the structure. We have right now we think it's all things considered so all things considered the way the business is running geopolitics the whole risk profile of the company. The other things we had going on in the last couple of years to.
Streamline IP, we believe that 50 50 joint ventures, the REIT structure.
We are working on is improving yellen and the <unk> team is doing a great job.
<unk> and their business and growing their business. It's the number one competitive position to serve softwood fiber products to China.
And we want to try to find ways to get as much of that value reflected for that 50% ownership position into the shares of IP that we can so the strong dividend we get the equity earnings.
<unk> to our fast growing Chinese market in an innovative way, we hopeful will resonate overtime ownership changes are always under consideration by obviously wouldn't talk about something we haven't done we are very comfortable with the structure. We have right now and we have very good partners.
And we.
Have a great management team, that's running the business very very well.
Okay. That's really helpful. I mean, I think all of us on the outside to see why a lot of respects.
Having a strong local market partner over there makes sense for IP I'll turn it over thanks. Thank.
Thank you Mark.
Your next question comes from the line of George Staphos with Bank of America.
Thanks, Hi, everyone. Good morning, Thanks for the details Mark and Tim I wanted to go back to <unk>.
Slide six.
And there's been this narrative from a lot of people in the industry that labor shortages in supply chain all the things that we've been reading and hearing about have not only increased cost but also prevented.
Converter is.
Integrated companies from hitting demand that they see ahead of them.
And certainly you pointed that in that slide would it be fair to say that.
Recognizing you're going to be some apples and oranges in this that the difference between the one 7%.
Box shipment trend that you saw in the third quarter relative to the channel growth that you saw or thank you saw one 3% was largely those constraints and.
Maybe thats, putting too fine a point on it but what do you think was the lost volume opportunity in boxes in the U S for you because of that and the related question would be.
How much of that.
Lost sales whatever the number winds up being recaptured and how much is permanently lost because some things that were shipping boxes for right now we're not going to be having.
Having hanukkah and Christmas in February or March So how would you have us think about those two questions.
So I think on the reason for the shortfall.
The quarter evolve something like this July we still had more.
Painter Borg shortages.
Parts of the box system, and we had a heavy order intake and in some cases, we just couldnt take the orders.
But I will tell you the majority of the business that we're not getting is new and incremental business. We're not we're not we're not seeding share in our existing customer base. So we are unable to always say, yes to an order when a customer wants a new customer wants to give us.
Additional business for the next few months or something not a long term contract. The biggest issue July was very difficult August was better.
And we were much closer to the market in August and.
Ian.
September we were basically tracking with the market. So we improved through the quarter and for US It plus it labor labor cost issue for us for US It was mostly the containerboard.
<unk> ability in the right box plant.
At the right time, so our inventory recovered nicely in the quarter, but the majority of that recovery occurred in the last month of the quarter. So the foregone sales really occurred in July and August and it was hard to go you Couldnt go back and get those.
That's why I'm confident even though it wasn't smooth through the quarter. We are entering the fourth quarter in a much healthier position. They are still as I mentioned on my remarks, a few areas in a few segments that use a specific type of board that we might make it only two mills that were still tight on.
And depending on where demand is in a slow trucks and trains or we may end up in an issue, but we are in a much better position to labor laws entire our demand our growth issue labor is a cost issue because we're asking people to work overtime to make more product. The board availability was our primary issue.
So mark would it be fair to say that again.
Again, there is 2% plus that was perhaps foregone, but you're in a pretty good position to recapture that in the fourth quarter or is that a I know over simplification.
It is an oversimplification, but I know what question Youre trying to ask it I would say, yes, we don't believe we've lost demand.
Demand the kind of demand that we couldnt take in many cases is not demand that is lost.
Our network is so flexible many many customers that don't buy from us today want us to be a part of their supply base and they still want us to be a part of their supply base in November when they come back to US okay. Thanks for that.
One question on pulp and then one question just in terms of other things that youre doing at the company to improve value. So as regards pulp and we covered this a lot on these calls.
And our colleague analysts.
Yes, you saw improvement in the third quarter, but if we do the waterfall into the fourth quarter.
We're back to relatively low EBIT levels for global cellulose fibers, yes.
Fluff is less volatile, but we're seeing obviously commodity paper grade prices dropping pretty sharply and so can you remind us what ultimately you would like to see what you think would be a fair EBIT.
Turned for the business.
For it to be.
A value creator within the IP portfolio and then my other question Youre, obviously doing some tremendous things to improve costs and improve value within the company the <unk> the <unk>.
Cost reduction and commercial initiatives.
I think you mentioned at least a couple of times on this call today and we've heard it throughout earnings season already these are unprecedented times in terms of cost and supply chain inflation.
Other things might you be contemplating away from cost, but on the commercial side that might be reflective.
Reflective of a new paradigm in how IP might need to address these challenges to improve return value for its shareholders going forward. Thank you and good luck in the quarter.
Thank you George on the first question on cellulose fibers.
Our business is a value creating enterprise for IP when the EBITDA margins are just north of 20%.
And we had that in the third quarter actually we had a value creating returns or there were some oddities in one offs. We've got our cost structure right now that the business any no forest products business has ever seen in our supply chain.
Gumming up that no one's ever seen I don't believe any of that will be permanent and so thinking about the business strategically at the current price levels at the improving commercial arrangements, where we're getting paid for the value we provide for our customers and a future cost structure that is a little more normalized I think we can be.
A lot closer to and we will hit some quarters, where it's a purely value creating enterprise and then the question is how do you get it to be their permanent lake like we have our packaging business and that's what we're working on on the other investment question. You asked an example of some of the things. We're working on that are not cost related will be primarily.
Almost all of our near term investments will be in the converting system.
And then.
Aside from just normal.
Protection of cash flow and your mill investment, but things like ideas that we have started to pilot and we've now done and it's working well the wide range of customer segments. We have so E. Commerce is a general set of customers on our segment is an entirely different set of demands and a plan that more.
General Food uses for example in boxes and having E. Commerce only small focused facilities that are located almost co located with our customers. As an example of investments that we are beginning to develop that will help us on the commercial side. It does two things it puts the right assets for the <unk>.
<unk> segments.
In place and it keeps that business from detracting from the efficiency of the larger plant, which was never maybe built to do that type of packaging at that kind of throughput and so you immediately unlocked capacity by making investment a you've essentially made investment b by just not running all.
That stuff in the current plants that it's running it and youll see more of that as we go forward.
Alright.
Thank you Mark Thank you, Tim I'll turn it over.
Good quarter.
Thank you.
Your next question comes from the line of Mark Weintraub with Seaport Global.
Thanks, Mark Tim So a couple of follow ups first just on George's question.
When he was asking about.
Box shipments and you answered.
Was.
Impairment for your relative performance, particularly in July I think part of the question also is relating to the overall industry box demand in the third quarter looked lower than what people had been anticipating an end.
Whether how much of that is being impacted by <unk>.
Supply chain or labor issues in the industry, where perhaps with the customer.
Particularly given the cost environment that we're in people are just trying to figure out what can be next steps here to get to the types of margins and so.
Civic two sort of from an overall industry perspective is there a view you can share as to how much demand may have been temporarily depressed versus maybe theres just more generic slowing going on in.
In the business environment.
Yes, Hey, Mark it's Tim So first of all.
Third quarter fourth quarter comps are tougher given what happened last year.
Thank you.
While we're seeing supply chain is affecting everyone. So you look across not only what we're doing in terms of trying to supply customers, but there are supply chain issues across almost every segment that we that we serve and that probably I can't quantify it for you, but we know anecdotally that it exists.
So.
You say the specific to the containerboard and box business those supply chain issues and labor issues. There also.
And impediment or is it more just more of the customer level from where you sit.
No I mean, we have experienced their own supply chain constraints and there have been at least anecdotally issues of customer.
Constraints as well I mean hiring.
Being able to source and.
And move product is an issue that I think is widespread across the economy and I think part of part of what Youre hearing Mark about the concerns about maybe the U S holiday season, and will you be able to get everything you want because people are probably going to operate on their prior patterns and they'll start to look at shopping whether it's.
<unk>.
Brick and mortar online in the November time period, I think theres going to potentially be a lot of disappointment and so the anecdotal comment Tim may is customers have told us they could sell and ship more if they had more employees too.
<unk> run their factories.
No.
They're working they're doing just what we're doing they are working over time. They are trying to hire people, but everybody is trying to hire the same people if you're in an industrial.
Supply chain, because it's semi to very skilled labor and everybody is competing for the same people and there aren't that many of them out there. So.
That will at some point I believe.
<unk> itself because.
There's a there's a ton of money as you all know pent up in and people and companies to buy things and I don't think that that pent up demand is going to go anywhere.
Probably going to pass through a period of frustration where people can't get everything they want you to see that in a number of segments, but I think the demand driver is the money people have to spend and consume and that's not going anywhere and I think once we can all produce what the demand level is through the value chain.
See I think robust demand in the <unk>.
Kinds of products that use corrugated for foreseeable future.
Okay great.
Sometimes you have in the past given an indication of where you thought year ahead box demand might be I realize this is an incredibly difficult.
We are predicting that right now, perhaps why I'm asking the question.
Do you have a view as to what the next six to 12 months on the box demand side might might hold.
That you can share.
Six to 12 months is looking in this environment looking out quite a long way.
I think we feel good in the moment.
Our cutoff as we because we were in October sequentially is up between four and 5% so.
We're taking it month by month quarter by quarter.
Okay, what is that year over year and curious if you could share that for the October.
Probably flattish.
A strong comp last year.
Great and one last quick one.
Follow up to you.
Mentioned three to four days more cycle time in getting board through the system.
On a percentage basis, what would it normally be how big an increase is that relative to normal.
Well, we move roughly 40 plus thousand tons a day so.
It's three to four so 120 to 160 <unk> been in some lanes, it's more than four days.
But it's a big number.
I'm sorry, I meant is it normally two weeks three weeks and it's an extra three or four days or with the.
Yes, we don't we don't typically talk about how we move product in between our facilities, but the increment is a big increments.
Okay. Thanks, Thanks, Tim.
Yes.
Your next question comes from the line of Adam Josephson.
With Keybanc capital.
Thanks, Mark and Tim Good morning, Hope you're well.
Hi, Adam.
Hey, Mark.
Just one on the dividend.
So can you just talk to your initial expectation obviously last December that you would reduce the dividend by 15% to 20% in conjunction with the paper spend you'd ultimately decided it would only be 10% can you just walk us through your thought process why 10 as opposed to the initial 15% to 20 or no dividend reduction.
And for that matter.
Can you just walk us through anything what transpired since.
Last December along those lines.
Yes, I think at the time, we were looking at historically the performance the papers.
Contributed to overall earnings and cash flow performance.
And then as we've gone through the year.
Even though we.
Would have wanted to perform better.
We've not had some of these constraints and issues around supply chain.
We felt good about the performance and we felt good about as we look out into the next couple of years.
The performance of the company from a cash flow standpoint, so the key message was.
Returning cash to shareowners as an important part of our capital allocation and we do it partly through <unk>.
Dividend, partly through share repurchases.
We felt like we had a latitude to.
Reduce the dividend by a smaller amount than what we originally pointed to.
Got it I appreciate that Tim one more for you and then just one for Mark just on the topic of guidance I've asked you. This on previous calls, but just given the enormous uncertainty supply chain inflation demand you name it.
How comfortable do you think you would see giving full year guidance come next year now that the paper spend is behind you quitted sales behind you.
Or are you concerned that there's just so little visibility that it may create more problems than it helps you by doing so.
Yes.
Yeah.
Probably a lot of time.
The transpire between now and let's say the end of January when we report fourth quarter and think about 2022.
So I think.
Seeing some normalization to some of these issues that everyone's pointing to would be helpful and probably necessary to give a longer term outlook for performance of the business.
In a quantifiable way, but I do think given.
The issues that we've come from and where we are.
Having repair the supply chain starting to scale the initiatives that mark covered in his commentary felt pretty good about how things are beginning to shape up for 2022, so let's.
Let's see let's see where we are by the time, we get to January.
I appreciate that and just Mark one one more on box demand for me, which is I think we were all caught offsides by what happened in the third quarter, we all expected some growth or speaking for myself at least.
The supply chain issues don't seem to be going away anytime soon is it reasonable to expect embedded in your volume guidance <unk>, if I take $65 million of growth in industrial packaging are you expecting to be up year over year in the fourth quarter are flattish or can you just give us any sense of.
What you think youre going to do or the industry might too relative to the third quarter, which was obviously unexpectedly flat because of some of the issues you flagged.
Yes, I think Tim mentioned.
The October experienced so far and on a year over year. He called it flattish we would expect pretty close to last year. So flattish on a year over year basis, which is which is on a pretty as you know out of a pretty tough year.
For us the comprehension that $65 million of earnings improvement from volume that Tim talked about is primarily kind of again IP specific.
A much better position with containerboard inventory.
Going into this quarter, so that we won't have to forego some of the sales opportunities. We just couldn't meet in the really the second and the third quarter. So that's why we feel confident our again, our restriction was primarily our containerboard available.
In theory, we could have pushed containerboard to our box plants by cutting off other customers that are that are justice profitable in just its strategic of course, we didn't we didn't do that and we wouldn't do that so now we had the ability to take these very high value open market channels that have really been growing nicely and our own box business and not be as constrained.
We have been by containerboard downstream from us and including US the labor component that our customers are dealing with.
Thanks.
We will begin to improve I think the demand environment and the supply chain issues in the third quarter and the labor challenges I think surprised a lot of people and a lot of different value chains and of course, they've been working on it theres a lot of innovative approaches to hiring people right now.
And that will produce some positive results I believe in the fourth quarter.
And at least from what our customers are telling us about their expected demand and what they want us to prepare for their planning on solving some of there for them.
Labor issues.
To have enough people to work to make the products. They have demand for so we think some of that will be getting better over the next few months.
Okay. Thanks, a lot mark.
Our final question comes from the line of Mike Mclaughlin with <unk> Securities.
Sure.
Thanks, very much good morning, Mark and Guillermo I appreciate you.
Taking my questions today.
Just two quick ones.
Really just supply chain, obviously, the tremendous headwind to volumes can you talk a little just a little bit more about the specific end markets themselves and if there were any sectors that either stood out as being advantaged or disadvantaged and then just specifically on E. Commerce. What are you seeing there, particularly as some of the larger ecommerce players whether it be Amazon Etsy have indicated more modest growth.
Yeah.
Well we.
We deal with most of the major players in e-commerce, whether it's.
B to C E Commerce, our BTB e-commerce, and our customers the ones, we have and we don't we don't speak for any any of the industry. The ones. We have are are still pretty bullish on their fourth quarter and are asking us to prepare for levels of demand that are still very very strong.
On your first the first part of your question around the supply chain I think anybody who's transportation heavy.
Like some of the food companies are ours.
Struggling with some of the same velocity issues that we're struggling with anybody who's taking in products from outside the U S and it has to get through the ports are running into product availability and then on the labor side I think it's a smattering really everywhere.
Competition is most heated in the more populated areas. So you might have a distribution center for an e-commerce player and a box plant from IP and to box plants from other people and other light manufacturing or some type of all competing for skilled labor if youre a food manufacturer in the middle of a rural area Youre labor situations, probably more manageable.
And that's what we see our labor situation, primarily shows up in our box plants, which are near cities and near a lot of labor competition. Our mills are more rural and they are they are in much better shape from a continuity of labor.
Just following up on that quickly. So would you say that your demand and your ability to satisfy demand, let's say it's better.
Way from major cities.
No not really.
No I was just making the comment on labor the problem with being away from major cities in the box business unless it's a a food.
Processor, that's located really that's where the customers and box users are you sort of.
The radical statement to say I wish my box plants were away from cities. Most of the manufactured products are near population centers on the box side, but can you go upstream in the value chain.
Where the containerboard is made it's made near the forest of course in most cases.
And so it's just a it's a less populated areas of labor labor availability and long term labor.
Loyalty to their employer is a lot higher.
Got it and then just one quick follow up just on European industrial packaging.
Was negative things about 4 million for the quarter, just some of the issues that drove that that loss this quarter.
I think the biggest issue in Europe, and I think that's what you asked about Europe packaging. There is two issues going on we have one large recycled containerboard mills. So there are 100% exposed to the recovered fiber market.
That cost really really rose and then you have the.
Kind of unprecedented natural gas cost issues in Europe.
And it'll take a little bit of time for product pricing to kind of.
Catch up with that so it was more of a timing quarter issue than a structural issue.
Got it.
Thanks, again and good luck.
Thank you Mike listen you can you can tell from our conversation. This morning, the questions and even our prepared remarks, it's really easy to live in this moment of craziness in the supply chain and really kind of dwell on it but I'm personally confident that we will continue to manage and overcome what we're dealing with today.
We've got a tremendous team that skilled and operating and they do a great job every day every week every month, we do expect as I mentioned in the prepared remarks and in some of the answers to the questions that we expect our margins to recover further in the fourth quarter and we expect to be heading into 2022 with significant momentum I'm equally confident in very.
Optimistic about our future. We just showed you two slides today on some of the value drivers we have a lot more to share with you as we go forward. We have the right plan the right people to deliver on our commitments to build a better IP. Tim took you through our capital allocation framework I'll say it again, we haven't been in this position on.
Cash generation and cash return ability.
Almost forever and we're excited about building a good portion of our total shareholder return on return of cash to shareholders dividend share repurchase and then value drivers and the focused IP delivers the other half which is going to come with the profitable growth that we have in our sights. So thank you for your interest in <unk>.
Actual paper, we really look forward to speaking with you again in the future.
Thank you for participating in today's international paper third quarter 2021 earnings Conference call you may now disconnect.