Q3 2022 International Paper Co Earnings Call
Yeah.
Okay.
Ladies and gentlemen, good morning, and thank you for standing by welcome to today's International paper third quarter 2022 earnings call.
All lines have been placed on mute to prevent background noise. After the speakers' remarks, you'll have an opportunity to ask questions to ask a question press. One then zero on your telephone keypad to withdraw question.
That's one zero again.
As a reminder, today's conference is being recorded.
Now I'd like to turn the conference over to Mark Nelson Vice President Investor Relations. Please go ahead.
Thank you Paul.
Morning, and thank you for joining international paper's third quarter 2022 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 of our presentation on slide two including certain legal disclaimers. For example, during this call. We will make forward looking statements that are subject to risks and uncertainties. We will also present certain non U S. GAAP financial information and a reconciliation of those figures to U S GAAP financial measure.
Yours is available on our website.
Site also contains copies of the third quarter earnings press release, and today's presentation slides I will now turn the call over to Mark Sutton.
Thank you Mark and good morning, everyone.
We'll begin our discussion on slide three.
The third quarter was a very dynamic and challenging environment, which had a significant impact on our earnings.
We experienced a sharp decline in demand in our industrial packaging segment and significantly higher cost headwinds from higher energy and distribution costs.
On a more positive note I'm very pleased with the progress of our global cellulose fibers team is making to improve performance in that business. They are successfully advancing our commercial strategy and achieve cost of capital returns in the third quarter.
Both businesses, we also delivered strong price realization and for the year, we expect to exceed our $225 million target related to our building a better IP initiatives.
Now back to the demand environment.
As we entered the third quarter, we recognized there are macro and macroeconomic uncertainties ahead of us.
And that our businesses are not immune to these risks.
However, these macro trends shifted drastically midway through the quarter, creating stronger headwinds than expected versus our previous outlook, particularly for our industrial packaging business.
Based on feedback from our customers and after observing order patterns across our various channels and end user segments.
We believe inflationary pressures weighed heavily on the consumer resulting in lower demand for goods.
This had a large impact on demand for packaging as consumer priority shifted towards non discretionary goods and services in the quarter.
In addition to our customers and the broader retail channel continued to work through elevated inventories in their products, which further reduced packaging demand in the quarter.
In response to these trends, we quickly aligned our production with our customer demand, which resulted in significant economic downtime in the quarter for our containerboard system.
Also our significantly lower export position versus prior years contributing to a higher level of downtime.
All of which sub to sub optimize our system from a cost standpoint in the quarter.
I would point out that our mill system continued to operate very well before being constrained by lower demand. The work we did in the last several quarters to improve reliability is paying dividends.
As we enter the fourth quarter packaging demand appears to be stabilizing at these lower levels.
Finally on capital allocation, we returned $434 million to shareowners in the third quarter, including $269 million of share repurchases. As a result, we've returned approximately $1 $6 billion of cash to shareowners. So far this year.
If we turn to the third quarter in particular on slide four revenue increased by 10% year over year, driven by strong price realization across our two business segments operating earnings and margins were lower than prior periods due to the significant macro headwinds I discussed earlier.
However, our free cash flow generation was stable in the quarter.
I would also like to take this opportunity to mention that we are making good progress regarding elo.
As I've mentioned before the complexity of the situation.
And our joint venture structure impact the pace of reaching a resolution.
But we feel good about the progress, we're making and we'll provide another update when there is more information to share.
I'll now turn to slide five which is one that we shared with you last quarter as we recognized that there were a lot of macro uncertainties ahead of us.
Our outlook for the fourth quarter, which Tim will share with you. Shortly assumes our earnings will remain under pressure in the near term.
However, I want to reinforce my confidence in the resiliency of IP and our ability to navigate through these dynamic environments.
At International paper know, what it takes to successfully manage through a business cycle.
And given the rapid change in demand it will take some time to realign and optimize our system to the current environment.
We have a wide range of options and capabilities across our large system of mills box plants and supply chain and we know how to leverage them, while taking care of our customers.
Also later in the presentation, Tim is going to share some specific actions that our teams have taken to shift production to our lowest cost operations.
And she had high marginal cost across the system. We're also continuing to invest in projects to drive structural cost reduction through efficiency improvements.
Finally, we have built a very strong balance sheet, which we will preserve because we believe it is.
Ensuring our financial stability and Optionality and it's foundational to our company.
Specialty can softer economic environments.
Yeah.
This allows us to continue investing in our businesses and to return cash to shareowners in a meaningful way, maintaining our dividend and through opportunistic share repurchases.
I'm now going to turn it over to Tim who will cover our business performance and outlook Tim.
Thank you Mark and good morning, everyone I'm on slide six which shows our sequential earnings bridge.
Third quarter operating earnings per share were $1, one as compared to $1 24 in the second quarter.
And mix improved by $151 million or <unk> 31 per share with strong price realization across both segments.
Volume was lower in industrial packaging as a result of the softer demand across all channels.
In global cellulose fibers demand was stable however.
However, pulp shipments were higher due to improved supply chain velocity.
Operations and costs are impacted by the non repeat of favorable one time items in the second quarter significant economic downtime in our industrial packaging business and higher distribution costs and other inflation.
Across all businesses.
As you may recall, our operations and costs in the second quarter benefited from $96 million or <unk> 19 per share of favorable one time items related to insurance recovery of four are preferable mill as well as lower employee benefit costs medical claims and workers' comp expenses.
Maintenance outages were lower in the third quarter as planned improving earnings by 13.
Input costs continue to be a headwind and were $75 million or <unk> 15 cents per share higher than the third quarter, driven by higher energy and chemicals.
Partially offset by lower OCC cost.
On slide 34 of the appendix, we provide details on our consumption of key inputs, including natural gas, which was a significant cost headwind in the quarter for our businesses in North America and Europe .
Corporate and other items include benefits from lower tax expense and a lower share count.
Lastly equity earnings were both.
We're below the quarter prior primarily due to lower sales price and FX related to <unk>.
So turning to the segments and starting with industrial packaging on slide seven.
We had very strong price and mix improvement in the quarter as we successfully completed implementation of our March price increase.
While also benefiting from higher average export prices and commercial initiatives focused on margin improvement.
As Mark mentioned earlier and the challenging macro environment resulted in much lower volumes and unfavorable cost at our North American and European packaging businesses.
Demand for packaging weakened significantly mid quarter across all channels and segments from lower consumer demand and retailer inventory destocking.
This large decline in volume impacted operations and costs in the quarter as we adjusted our system to align our production with our customers' demand.
These actions resulted in approximately 400000 tons of economic downtime across the system, resulting in higher unabsorbed fixed costs and a sub optimized system.
This represented approximately one third of the higher costs in <unk> quarter over quarter.
In addition, we're not constrained our mills ran very well, which increased the amount of economic downtime needed to match the reduced level of demand.
Sequentially operations and cost.
It was also impacted by significantly higher distribution cost inflation on materials and services and the non repeat of favorable one time items, we discussed in the second quarter.
It also includes some additional spending on recovery boilers embark boilers across our mills to make our own energy given the significant increases in natural gas prices.
Input costs were another significant headwind in the quarter and much higher than we expected primarily due to higher energy costs that were only partially offset.
By lower OCC cost.
These cost headwinds are even more significant for our packaging business in Europe for natural gas prices doubled since the second quarter and averaged about nine times the normal level.
Turning to slide eight we thought it would be helpful. If we share some additional perspective on underlying segment trends for our corrugated packaging business.
As shown on the previous slide our U S box shipments were down four or five 4% year over year.
Our overall U S channel was down five 9% as a reminder, our U S channel includes U S, but the U S box system.
As well as our open market containerboard customers in our equity partnerships with strategic sheet feeders.
In the third quarter, we saw demand decline across all end use segments.
Hello indicators represent segments, where the demand decline was less than our overall average of five 4% in the red indicators represent declines.
That were worse than our overall average.
Segments, including beverage durables, and Nondurables, which are more discretion discretionary in nature came under the most pressure as consumers had to make choices, while dealing with high inflation.
In addition retailer inventory Destocking has exacerbated.
The demand declines for most segments in the near term.
Based on feedback from our customers on our performance in October demand appears to be stabilizing at these lower levels as companies to continue to work through their inventories in the fourth quarter.
Despite these near term headwinds, we understand the critical role corrugated packaging plays in bringing a central products to consumers and believe that IP is well positioned to grow with our customers over the long term.
Turning to slide nine as Mark mentioned earlier and the software demand environment, where we are able to run our systems at full capacity.
We have the ability to shed high marginal cost due to a wide range of options and capabilities across all of our large system of mills box plants and supply chain.
For example, we're shifting between fiber options based on the marginal cost of wood versus OCC.
In this case, our mill teams to consider the total cost to process the fiber, including the benefits from Omega energy when consuming wood.
Versus the cost of natural gas used to process OCC.
Another example would be in the supply chain area. Our teams are reducing premium freight through mode optimization and increased availability of lowest cost carriers.
At Mills were working to lower our planned maintenance outage caused by reducing overtime and premium pay that is that is traditionally associated with the shorter schedule.
We are also continuing to invest in our operations to drive structural cost reduction from our efficiency improvements in the areas of fiber and energy consumption.
Ultimately, we are focused on restoring margins to historical levels by aligning our production with customer demand, while optimizing our cost structure.
Turning to cellulose fibers on slide 10, I'll start with an update on the demand environment and supply chain.
And for fluff pulp remained stable across all regions feedback from customers continues to indicate that fluff pulp inventories are near historical lows.
We are experiencing moderate improvement in supply chain efficiencies. However, they continue to remain stretched driven by ongoing port congestion vessel base.
We believe fluff pulp will continue to grow over the long term and are confident in the central role of absorb a personal care products in meeting consumer needs.
Taking a look at the second quarter performance price and mix improved by $62 million due to the successful execution of previously announced price increases with solid momentum as we enter the fourth quarter.
Volume in the quarter was higher due to some improvement in the supply chain velocity velocity. However, I would note that backlogs remained above normalized levels due to ongoing logistics challenges.
Our mills continue to run well operations and costs were unfavorable in the quarter due to higher distribution costs and non repeat favorable one time items in the second quarter.
Planned maintenance outages were lower by $26 million sequentially, while input costs were higher by $12 million.
Turning to slide 11.
Global cellulose fibers business continues to make significant progress.
Towards growing earnings and delivering cost of capital returns in the third quarter and the business remains well positioned to sustain this level of performance in the fourth quarter.
Our teams successfully deployed our commercial strategy focused on building strategic relationships with key global and regional customers and aligning with the most attractive regions and segments.
We are focused on creating value for our customers by delivering products that meet their stringent product safety standards and deliver innovative value and.
In addition, we are driving structural margin improvement by ensuring we get paid for the value we provide.
Today, we have made solid progress in our fluff pulp contract negotiations, which will provide additional commercial benefits as we move into 2023.
We are committed to building on this momentum and delivering value creating returns over the business cycle.
I would also note that this is a key part of building a better IP initiative and the category strategy acceleration.
Turning to slide 12, I would like to update you on building about our IP set of initiatives, we're making solid progress in delivering $70 million of earnings in the third quarter for a total of $175 million year to date and we're on track to exceed the high end of our full year target.
About half of the benefits to date are from our lean effectiveness initiatives by rapidly streamlining our corporate and staff functions to realign with a more simplified portfolio.
We have already offset 100% of the dis synergies from the printing papers spinoff.
Although most of these benefits have been achieved we will continue to pursue additional opportunities.
The process optimization initiative has the potential to significantly reduce cogs cost across areas, such as maintenance and reliability distribution and logistics and sourcing as we leverage the advanced technology and data analytics. These initiatives will deliver meaningful benefits in 2023, as we finished implementing new <unk>.
Abilities across our businesses.
And finally strategy acceleration is about delivering profitable growth through commercial and investment excellence.
Getting our global cellulose fibers business to deliver value, creating returns is one example of this.
We are also focused on profitably growing our industrial packaging business by improving margins and investing for organic growth.
Turning to slide 13, and a look at the fourth quarter outlook as Mark mentioned, our earnings will remain under pressure in the near term given the current demand environment.
With that I'll start with industrial packaging.
We expect price and mix in the export channel to be lower by $10 million.
Volume is expected to decrease by $30 million with four less days sequentially in North America.
And the traditional seasonal pickup from holiday demand is not expected to be as strong this year.
This will be partially offset by seasonally higher produce volume in EMEA packaging.
Operations and costs are expected to decrease earnings by $120 million.
A little more than half of this is from the higher unabsorbed fixed costs, resulting from lower volumes as well as seasonally higher cost primarily from energy consumption and labor and benefits.
The remainder includes such items as inflation on materials and service services and timing of spending.
Maintenance outage expenses generally flat and lastly input costs are expected to decrease by $80 million from lower fiber and energy costs.
In global cellulose fibers, we expect price and mix to improve by $20 million on the realization of prior increases.
Volume is expected to decrease by $10 million based on timing of shipments through the supply chain.
Operations and costs are expected to increase by $5 million due to seasonality, while maintenance outage expense is expected to increase by $34 million.
Lastly, input costs are expected to increase by $5 million, primarily related to energy cost at our converting operations in Poland.
Turning to slide 14, I'll take a moment to update you on our capital allocation actions in the third quarter.
As Mark mentioned earlier, we have a very strong balance sheet, which we will preserve because we believe it is core to our capital allocation framework.
Our 2021 year end leverage was two three times on a Moody's basis, which is below our target range of two five to two eight times.
Looking ahead, we have limited medium term maturities with about $1 3 billion due over the next 10 years.
And finally, even in this environment the risk mitigation strategies. We've taken two are to ensure our pension plan remains fully funded.
Our in place and are delivering.
Returning cash to shareowners as a meaningful part of our capital allocation framework.
In the third quarter, we returned $434 million to shareholders, including 260 time million through share repurchases.
Which represents six 4 million shares or about one 8% of shares outstanding.
As a result, we've returned approximately $1 $6 billion of cash to shareowners. So far this year.
In October our board of directors authorized an additional $1 5 billion of share repurchases, which brings our total authorization to approximately $3 4 billion.
Going forward, we are committed to returning cash through maintaining our dividend and through opportunistic share repurchases.
Investment excellence is essential to growing earnings and cash generation, we are targeting between $900 million to $1 billion, which includes the funding cost for the funding for cost reduction projects with attractive returns for strategic projects to build out capabilities and capacity in our box system to support future profitable.
Growth.
We will continue to be disciplined and selective on assessing M&A opportunities that may 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 create compelling long term value for shareowners.
And with that I'll turn it back over to Mark.
Thanks, Ken for all the detail look this is clearly a very dynamic environment with a lot of moving parts and as I look back across our company I'm really proud of the improvement we've made in customer service.
Over the last several quarters.
Sharing where we weren't in the middle of last year with the containerboard inventory issues and box plant availability for our customers to reliability improvements we've made in our mill system Pelican global cellulose fibers and in containerboard.
I feel really good about because we are running very very well.
Some cases at levels productivity levels.
The best we've ever run.
I also feel good about the progress our global cellulose fibers team is making and the trajectory of the profitability earnings.
And business model changes, we've made that Tim described a bit earlier at the same time.
All satisfied with the level of our profitability, which has been impacted by supply chain disruptions inflation and falling demand in the second half of this year, but I am certain we will make improvements in this area I'm also very certain about the resiliency of international paper during the past few years, we have significantly enhanced our financial strength and flexibility.
A lot of risk out of the company. This strong foundation makes IP well positioned for success across a wide spectrum of economic environment. So with that operator, we are ready to take questions.
As a reminder.
To ask a question press one zero.
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Thank you, we will pause a moment to compile the Q&A roster.
Our first question comes from Bank of America, and the line of George Staphos. Please go ahead.
Hi, Thanks, very much hi, everyone. Good morning, Thanks for all the details Mark and Tim.
First question broadly on containerboard and the second one on pulp.
In containerboard can you talk to us about what benefit you expect to get from the optimization efforts on a run rate basis.
The horizon would be in there in terms of when you expect to be at a more optimized level that you're targeting and how to.
Current box shipments and trends play into your optimization.
What are you seeing early in the quarter.
So early in the quarter, we are seeing as Tim mentioned box shipments still kind of stabilize from where they exited the third quarter Thats down six.
Sat herself from where the in quarter progressively got a little worse.
Yes, I think George the issue on optimizing.
We have called in the past.
Very of aligning our cost structure I think part of what's unique right now compared to maybe prior periods as the amount of production slow backs were taking over a relatively short period of time and in a period, where most of our maintenance out almost all of our maintenance outages are behind us if you look at Pryor.
<unk> adjusted our output to match our demand.
Spread out more evenly some of it was in the first half of the year, where we also had maintenance outages. So the third quarter, we get a lot and it was really in the last two months of the quarter.
In the fourth quarter, a spread out more evenly, but it's but it's still trying to anticipate the demand that we think we see but being willing to turn it back on if the demand picks up and so I think that fourth quarter is going to be a transition every quarter I will say from.
From the last time, we took economic downtime in our containerboard system and any appreciable amount you'll all remember that was 2019, if we look at the variable cost per unit of production in that environment, we're actually doing a little bit better than that what's different. This time as we're doing this in a really high.
Generic environment. So the price part a lot of our input is persistently sticky we think some of that will start to relieve itself in the fourth quarter, but it hasnt all happened, yet and we weren't dealing with that part of the cost.
<unk> in 2019, but our teams know what to do.
<unk>.
The goal right now and we also didn't have a high energy environment than the goal right now is to maximize our own make energy is any anybody who makes their own energy in any industry, we would be trying to do right now.
But you got to match that goal with the actual production output you need and that changes the way we run our pulp mill. So I think we will see during the fourth quarter continued improvement in how we shed those marginal cost.
Thanks, Mark and my other question on pulp.
You said I believe demand for Tcf with stable.
Your customers' inventories are still relatively low you've seen some improvement, but not a lot comparing phrasing there in the supply chain.
So with inventories low.
Did customers pick up their purchases relative to where they otherwise would've been because they could access more material because of supply chain has improved and as we look out over the next couple of quarters, presumably the supply chain improves.
Do you think that will lead customers to purchase more and improve their inventory position or know that it'll be much more hand to mouth because supply chain has improved and so the need to have inventory will diminish somewhat thanks guys. Good luck in the quarter I think the low levels of inventory for this particular type of product given its not easily <unk>.
Substitutable in the short term given the qualifications and low levels of inventory make up the value chain very nervous and so I think customers will work to get to some level of comfort that they are used to I don't think anyone will trust the supply chain for quite a while to be the answer to I can run it with a lot lower inventories.
Some of our shipments as Ken mentioned or alluded to we shipped a little more than we expected partly because the supply chain velocity improved a little bit as you paraphrase.
We don't know for sure if that's permanent or if that was just in the third quarter. We hope it's going to get better because it will help us lower our cost.
But we still have the issues in the market for example.
China's market is still semi closed with some of the lockdowns.
We think the inventory situations gotta remain strained, meaning low for finished products throughout the value chain for us.
For the coming several quarters and so.
We think that the demand is stable it could improve if China figures out their vaccine and all of that strategy and may be open to the economy a little more.
But right now we what we see is stable demand going forward a lot of commercial improvements that will flow into 'twenty three.
And the ability with a little bit better supply chain to really start to take cost out of our system that we get to keep.
Thank you Mark.
Thanks George.
Thank you. Our next question comes from city and the line of Anthony.
Laurie Please go ahead.
Hi, good morning.
Just following up on inventories maybe on the containerboard side, how would you characterize customer inventories.
Here in October as well as your own inventories and to the extent that there's maybe an overhang still in the channel like how long do you think it might take to work through that.
So I think there is.
If you go back to the slide Tim showed Anthony with the yellow and Red segment descriptors those that work the demand declined more than the average demand those are the customers in those segments.
Very big customers National type accounts, and we have very small customers inside of each of those.
Little segment descriptors, those that were greater than the average.
A big portion of their commentary to us on their order pattern was too much inventory and we think they think best I can tell from the consumer I watched a few of their earnings calls earlier. This week, that's a fourth quarter unwinding process, but may be not terribly much beyond that if you look at the other part of that chart where R. R.
Decline in some cases.
And break it out but in some cases, we had customers inside of segments that the demand in decline at all and they are very big and important customers to us and they would say their inventories are a little high but.
We will see what happens with fourth quarter consumer demand or they are predicting a little less of a holiday pick up of any pickup at all and they will feel like they are in great shape. So it's really a tale of those those segments on that chart, we showed but even in the worst case, we think most of our customers believe that this is a work it through the fourth quarter process.
Obviously, you hate to make a prediction because theyre. So it seems to be so many variables that come up and inflation is still persistent and high consumer can be fickle after that.
After the holiday period, and spending a lot of money on services, what happens to the goods market in the first quarter I think that's what a lot of us are trying to figure out right now.
Yes.
Okay, that's very helpful.
And then just with the updated Capex guidance can you remind us kind of how you think about normalized.
Maintenance versus growth versus regulatory capex to the extent that you're maybe trimming some of that maybe where is that coming from and then.
Understanding you're not giving guidance on 'twenty, three just kind of directionally or their capital needs for the business that might cause capex.
Go higher next year could it go lower or do you think youre kind of in a good position here.
Just just any incremental thoughts on capex.
Great. Thanks, Anthony it's Tim so over time longer term, we will look to have capital investment around the level of depreciation that can be a little bit higher and some years.
What usually drives that it's not so much maintenance and regulatory we try to keep that fairly consistent.
We look over a five year period, we have five year plans about how we're going to do maintenance schedules, what tends to drive it up and down a little bit on the margin tends to be more of the strategic projects, whether it's building out capability or more recently.
Adding capacity in our converting operations.
So, but the 900 to a $1 billion is not necessarily us.
<unk> pulling back capital it's just.
It's just.
Coming to the realization this close to the end of the year that as hard as we've tried all through the year supply chain has been a limiting factor about how much capital you can have installed and have it be productive in a given period of time. So so that's the reason for the adjustment just acknowledging that we're not.
You're going to get as much done as we thought we were earlier in the year and longer term, we'll try to be around depreciation, but where there is either good cost reduction projects or or strategic needs building out capability.
It could be a little bit higher than that in given years.
Okay. That's very helpful I'll turn it over.
Thank you. Our next question comes from Bank of Montreal, and the line of Mark will be please go ahead.
Thanks, Good morning, Mark Good morning, Tim.
Morning.
Mark I wondered just to start out you took a lot of economic downtime in the third quarter.
And you're suggesting more in the fourth quarter I, just wonder given that level of downtime in <unk>.
Coupling that with all the new capacity, that's coming into the industry over the next 15 months or there is some more efficient ways to adjust your capital base over the next 12 to 18 months, whether it's some permanent moves there maybe moves like we saw at Valeant several years ago, when they just mothballed one of the machines.
Or is just continuing to take.
Take a kind of rolling downtime across the system is that the is that the optimum approach. It's a great question Mark I think the variables. We look at it of course, we don't know what the demand environment is going to be.
Over the next year or two and we don't know exactly what the ramp of the new capacity you mentioned will be so there's a lot of variables. The other thing thats a little different.
Any unique.
In addition to the to the algorithm we use to figure out how to take downtime is one you have very high natural gas costs, which which changed the competitiveness of your recycled mills and we have a few that are 100% recycled.
The flipside of that is you got a very expensive and in congested supply chain and IP example would be our large recycled mill that's up in the Midwest might be a candidate to scale back for energy costs by defeat indicates our ability to.
Save on logistics, because its so close to the market. So one of the reasons you see us doing more of that as you described rolling so not not fully shut them down but adjusting the output of multiple plants is to try to make all of that balance get our get our integrated mills too.
<unk> close to energy independent as possible and our non integrated mills, which tend to be located physically in places and they were built for that reason to be close to the end use market and there beyond a lot of the rail chokepoints to get those to serve as much as things change as supply chain cost change is energy changes.
It will lead us to different conclusions. So that's how we make that decision on how much we run to our order book and where we do it.
Okay, and then I wanted to just turn to soluble so I know that this fall.
The strategic effort and so you'll have sort of the last few years has a number of different elements.
And so just if.
If we look at the whole price charts right now they are at the highest level any of us have ever seen. So can you just help us on this call get confidence that if pulp prices start to rollover, you're actually going to be able to maintain those close to capital returns going forward in cellulose.
Not just the market that's gotten you there at this point.
Yes, I think if you look at a couple of indicators one of the things we've tried to do with our value proposition is to make.
Arrangements with customers tend to use the word moving to strategic.
Arrangements versus just contractual volume for price.
And two how we participate in the different regions of the world.
Given the nature of the product and what requirements a customer has.
From the standpoint of substitution and making sure we get paid for that and so you can see some evidence in certain charge in certain regions, where that phenomena has already started to occur and there is no impact on our.
Absorbing products.
Economics, and the reason for that is our strategy.
<unk> adjustment has been to work with our customers and to and to basically have the effective decoupling that as much as we possibly can but your point is well taken we will see how that plays out as we go through.
A normal business cycle.
Very comfortable that we've made structural changes in the way, we go to market and I'm, not saying you won't see any cyclicality, but I think you will begin to see a different spread over time than you've seen in the past, but the proof will be in the coming quarters I'll take you back Mark to what I've said over.
A year ago.
Investors can expect with the changes, we're making forget global cellulose fibers to improve quarter after quarter after quarter that we will be at the cost of capital returns.
In the second half of 'twenty, two and then you can expect the business as we enter into 'twenty three to be a value creating business in so far.
That's that's the track we're off so let's keep talking about it quarter after quarter I think your point is a great one and I think it'll it'll we'll know we'll learn a lot more about whether or not our strategy adjustments have resiliency and sustainability as we move into 'twenty three I believe they do.
Okay. That's helpful. Marc I'll turn it over to some other questions.
Thank you next from Seaport Research partners Mark Weintraub Your line is open.
Thank you.
So I'm just trying to think through workout the the downtime the magnitude of downtime that you guys took in the third quarter, obviously acting quickly to adjust to the demand environment.
And I think your North American system order magnitude $13 5 million tonnes, so roughly $3 5 million tons a quarter.
And just the economic downtime itself, what's about 400000 tons, which if I'm doing my math right I'm not missing something.
Suggesting you're kind of in the $85, 90% range in terms of operating rates.
And and and.
And basically containerboard production, presumably was down by 10% plus year over year.
Two questions on that one are you actually are you are you have you been bringing containerboard inventory down in your system. During this quarter and and then you also made the comment that you are if I understood correctly that in the fourth quarter, you're probably going to be taking out as much or maybe more.
Did I hear that right.
So mark.
It's a multifaceted question, let me let me just take you back at a higher level. So the containerboard system has a certain capacity, it's a little higher than the number you mentioned and the way we run it is not by quarter. I mean, we have to do what we have to do in a single quarter, but the way we think about our system is we have a certain amount of output.
Capability.
We strategically target about 3% of that and you can look at our.
Earnings calls from the past and how much volume we take off of planned maintenance ends up being around between three and 4%.
There is another 3% to 4% that we tend to average just in terms of being flexible for customer service for unforeseen problems and so every once in a while to match a change in demand.
Slide 2019, we'll adjust our output to match reduced demand environment and that again has multiple variables. It depends on how strong the export market is during the same period of time, sometimes the markets are connected sometimes theyre not that number as a percentage of our total capacity of <unk>.
<unk> was.
Probably six 7% of our total capacity once.
And in a multiyear period and I don't know what its going to be we have forecast. We're just trying to match up the principle of we're going to make the containerboard we need to serve the order book, we have and to maintain what is much healthier inventories for our supply chain and those numbers as you know for almost every industry are alert.
It'll hire in this kind of supply chain environment, but that's the way you should think about it think about it big picture Youre not in a 60 or 90 day period. There was a system. There is maintenance that's flexibility time and occasionally there is an adjustment and that's the kind of way. It is going to play out of roughly the percentages I gave you.
If you annualize what's unique about this and I've mentioned in a prior answer is a market slowdown in quarters that normally the market is not slowing down.
And for IP and quarters, where we don't have any other maintenance outages that would normally be taking production offline like we had in the first half of the year. So that's the differences that's what adds to the cost mitigation challenge.
Thank you hopefully just.
To clarify I guess, what I'm trying to ascertain is whether or not the amount of downtime you took.
I appreciate all the talk about maintenance and levels, along those lines et cetera, having an impact but.
But were you what was there almost some catch up.
If we were to remain in the down 6% type of demand.
Demand environment would you anticipate continuing to take this level of downtime or was there the degree of downtime on the board side of things is even more than what the box shipment.
Type of environment would have indicated so again locked away you need to think about the answer to that question is.
Any downtime, we take is a product.
Product of doing the analysis of our North American order book, our export order done.
Any maintenance outages that would already take production offline and I think Tim mentioned at how well we're running in the moment. So we were running really really well right now.
I E, we're making too much containerboard, which is where you want to be that's what we worked on to be reliable what that means in plain speak is the lack of reliability interruptions in the quarter, which is a good thing, but not in a quarter, where you necessarily don't need the production. So you end up slowing back by at least you didn't.
Half of repair costs. So it's impossible to answer the question without knowing the answer to all four of those variables I just gave you and.
That's really helpful and I guess I think basically you're you've improved your system you can actually make more product that could continue like that which I guess would then sort of go back to Mark will these question a little bit. It does that then give you a little bit added flexibility to think about your footprint.
On a different basis to if you've actually and it is that a fair observation.
I think it's fair to think about the way I answered <unk> question is in the moment, where you're considering which lets taking right now you look at the other variables.
Transportation and logistics costs, and like energy cost and you make the decisions for production at the lowest I think Tim used the word the lowest marginal cost operations and that that could change in a month because of the hurricane that wet the woodlands and now you've got high costs wood.
Thank you.
My point is not not to be.
Evasive, it's a dynamic set of variables and we make those decisions not real time, but it's a.
Seven to 10 day period, so if the answer to the question how do we make the production we need at the lowest cost involved some of the examples you and Mark mentioned.
And then that's what we would do but right now with the variables, we have with supply chain and energy that's not the most cost effective way to do it.
Thanks very much.
Thank you and our next question comes from Truest Securities in the line of Mike Rocks. Linda. Please go ahead.
Thanks, Don Hey, Mark Thanks for taking my questions.
Just wanted to follow up I guess just one.
Your inventories as well as just following up on Mark's question Nancy choices about the overall.
I got a level of your inventories during the quarter.
Give us a sense of where they stand.
I remember last quarter, you mentioned in your containerboard inventories are now back at sufficient levels.
But with demand slowing any questions either has given the economic downturn.
Given some of the slow backs would be fair to say that your inventories have declined.
Sequentially and relative to your comments from last quarter.
Yes.
So.
We were back where we needed to be part of the reaction that you saw in the quarter. It happened.
Midway through the quarter as Mark referenced.
It was it was really in response to making sure that inventories don't get away from us if we're running to demand. We're trying to look at you know our Sanofi process is trying to look at not only in the moment of a further out in time and what kind of.
Product availability needs, we're going to have so we were able to keep inventories in line with where we want them through the way we ran the system.
And Mike again, I'll, just reiterate the decisions that we made.
Our Florida, what we can see upcoming but think about the calendar. The other variable is youre, taking adjustments to inventory at this time of year versus in the middle of the year as we enter into the first half of the year, which is our heavy 75% of our maintenance outages. So part of our normal operating strategy.
As to forget how do we make sure we had the inventory we need in the first and second quarter of next year. So we don't lose a sale because we did something to inventories in the moment in the fourth quarter without looking at whats getting ready to happen. So that's factored into our decision said well, it's not just about the inventory to match.
The demand in the fourth quarter, it probably would be if we were in the second quarter because the outages are done you've got plenty of inventory you don't have any more mills down, but that's not the case here, we're getting ready to enter into our normal outage season and that factors into what we think we have to run whether or not there was an economic slowdown or not so we can get through our outages, yes. The other thing.
I would add is even though we've seen some modest improvement in transit times with ocean vessels.
On the ground in North America rail and truck.
Our network of supply chain has not picked up a lot of velocity. So we're still dealing with the extra time, it takes to move product and between mills and converting operations.
Got you I appreciate the color and just one quick follow up.
If demand remains depressed.
This quarter to the earlier part of next year.
Would it be fair to say.
You continue to let's say production they are slow back.
Is that the point at which you would draw down your inventory you said, Marty you mentioned <unk>, but would it be fair to say that if you were really <unk> and demand. The overall demand environment minus 6% you would start to draw down your inventory at that point.
We would run the system to match the demand that we have so we don't know what the demand is going to be in the first quarter, but as we get closer to that we'll have a better idea and if that results and the supply chain velocity has improved and we don't we don't solve for the inventory level number we solve for making sure we can take care of our customers and.
We have the.
The business prepared because what we make today gets used.
In the future not to pay and so we've already made the inventory for today yesterday. So that's why it's difficult to give you a finite period answer there's again a lot of variables, we need less absolute inventory when the supply chain is flowing than we do when it's not and it's a long way from flowing in.
And especially in the rail area and a lot of our mills are in the southeast deep South east, whereas it'll rail chokepoints are not getting any better and the labor situation is not getting a lot better. So we're working with what we know right now and what we know right now says the inventory levels, we have the absolute number matches the slow velocity.
The supply chain, if that changes, we'll adjust our production output to match. The fact that the inventory is moving faster.
So it's not a matter of will be lower inventories, it's a matter of all of those variables lead to an inventory number.
Thank you I appreciate all the color good luck in the balance of the year. Thank.
Thank you.
Thank you then our next question comes from Adam Josephson with Keybanc. Please go ahead.
Mark and Tim Good morning, Thanks, very much for taking my questions. Mark just one more kind of way of asking that capacity question that I think both marks were getting at is obviously you have to hazard a guess as to what long run demand will be to figure out what the optimal level of capacity is and obviously there was this exceptionally unusual.
<unk> search in demand during the pandemic and now we're starting to see.
The other side of that so when you're thinking about the right amount of capacity to have long term how are you thinking about the right.
The level of demand, obviously, it's near impossible to forecast it but are you thinking that 2019 levels were kind of normal or.
What the long run rate of demand growth will be.
Obviously, there is capacity coming that I think mark will be mentioned so how are you thinking about all those factors when determining what the right level of long term capacity is for you.
Again, Adam I appreciate your coming at it from a different angle I mean, the long term capacity. We think we need is based on what we believe about the markets, we serve and the markets. We serve ex the pandemic just normalized volume unless there's some major change in the structure of the U S economy, it's been a 1% to 2% growth market.
For boxes.
And the open market similar because we're selling to people who make boxes in the same market and global containerboard Virgin containerboard to service the rest of the world and to create recycled fiber has been a 2% to 3% growth and we've typically try to position ourselves to have.
Positions in those channels in the most profitable areas and so I'd say right now.
Again with those numbers in mind over time, not not here in the moment, but over time, we are good on containerboard, we just need the Riverdale investment in 2020 that was another good chunk of high quality White top we made small project investments across the North American system and.
In years prior to that.
<unk>.
I think we've got the containerboard capacity, we need we're working on different grades light weight different things like that but I think that's how we think about the containerboard capacity we back it in to what do we need to containerboard based on what we think the end use markets are going to need for box, which is the biggest and then the actual open market we sell in North America.
And export and those are the numbers, we use we don't we didn't change our strategy because of the pandemic demand what we what we did is we we.
We realize we can't run as close to the.
Full capacity that we were running in our converting operations, meaning you can always use a little labor to get some extra capacity by working some overtime, but you can't do that forever because it is people and they can't do that forever. So you do need to have a better asset strategy and we learn that through the pandemic Amendment, we didnt change our strategy on what we look at long term.
<unk> of containerboard and its uses no interest.
I think part of what you were getting out of them is the pull forward. This maybe some of the industry. So right.
Primarily around durable goods.
Durable goods is a small segment is small for us is small.
Total.
And a lot of what people are buying our consumable items. So.
It's not like.
Maybe in some cases, there is demand pull forward a little bit.
Oh, I don't feel like that.
The bulk of it is just I think.
Yes, I think that we have seen the shift that mark talked about between goods and services and that'll that'll normalize at some point too.
Yeah, No I appreciate that and just Tim one on the dividend. So your balance sheet, you've done a lot of work to get it in much better shape than it used to be in and kudos to you for that when I think about the dividend payout. So.
In light of what you're guiding to for this year. The 900 to a 1 billion if I assume that you sell or do something with your L. M stake that would mean that you wouldn't get that $200 million ish of cash dividends next year and thereafter for that matter.
Such that ex U.
You'd be paying out I think what 90% of your free cash flow. This year and obviously you have a view aboard trough cash flow with a normalized cash flow cash flow. How are you thinking about the dividend payout in light of what you're guiding to for this year in light of what Youre, what youre, hoping to do with a L M et cetera.
Yeah, that's a great question, Adam I mean.
The way, we think about it is we say $40 to 50% of free cash flow in our minds and I think we've said this before but.
That's not in every moment of.
Time that is through the cycle and there have been moments when our dividend payout has been higher than that and it's been right down on the bottom end of that at times too. So I think we're in a moment.
But we still believe that.
The dividend is structured we have bought back a lot of shares at the same time.
Is still perfectly situated in that 40% to 50% of free cash flow.
We still believe in the resiliency of our cash flow over time, yes, I think it's important to know Adam.
What Tim said is really really important 40% to 50% over a cycle, which means it's going to be at the upper end and it could be the number you just gave and it could be much lower and be at the lower end. It is even dipped into 30 30 something percent of free cash flow and the dividend is really important to us it's really important to our investors that's what we hear from.
Investors and it is important for us to make sure that it's not a tactical thing that we calculate free cash flow for a given year and then the sale of 50% of that that's not how we do it it's 40%, 50%. It's an overall guideline through a cycle and a lot of things happen to converge in trough.
<unk>, which you might describe as low demand in all its negative impact usually followed by lower cost environments unwinding of working capital cash as you know has many components, but that's the way for people to think about our dividend is not a calculation in the moment pick your moment quarter half year year, it's through a cycle.
And I just wanted to be really clear about that.
Thanks, so much mark.
Thank you then our final question for today comes from Deutsche Bank and the line of Kyle White. Please go ahead.
Hey, good morning, Thanks for taking the question I was just hoping to get some more details on demand I know, it's been talked about a lot, but I'm just trying to understand the two to two large dynamics impacting demand there the destocking impact.
This scenario crushers like consumers.
We kind of knew about the destocking impact heading into the quarter, but you mentioned that demand saw a sharper decline midway through so it seems like inflationary pressures are now taking over and having a larger impact on on demand going forward. You said that not carry forward into 2023, such that we could see mid single digit decline in the first half of 'twenty three or just.
What are you seeing now and how are you thinking about that for next year.
Kyle I think it's a really great question, that's the kind of conversations we're having with customers our business doesn't have that long of a cycle. So we got some visibility into the fourth quarter. It's really there's really not a lot of visibility other than.
Algorithms and analytics into the first quarter, but what I think our customers said, what they saw and then hence we saw is as inflation remains persistent customers had to make choices. They start and you look at the time of year, where in approaching holiday is a little more travel, they're making choices to to spend money on services are.
Save money for our future airplane flight over the holidays and backing off of some discretionary things. So fast forward during the fourth quarter and you flush out all that service spending where does the consumer find themselves in the first quarter I think it has a lot to do with <unk>.
Whether this quote slowing market and slowing economy actually creates different policy interest rates, how does the consumer feel.
Listen to the bank Ceos and they have a general view that the consumer is still in pretty good shape and Thats true looking at bank balances and all that but that will stay that way if inflation remains at.
At 9%, 10% and rents are high and all the other things that's that's the real variables, we're watching and our customers are watching.
But we'll deal with whatever the environment is in the first part of next year, but I think we have to see what does the consumer do as they as they work their way through at least in this part of the world are very heavily <unk>.
Service oriented holiday spending pattern and will they make choices that are different and it looks like they're making choices on a less goods more services, but after the services are all spend will the goods replenishment as Tim said some of this is consumables will that be gain a normal cadence in the first quarter.
It's a great question, we're watching it we will know a lot more obviously as we go through the fourth quarter and when we're talking to all of you at the end of January with our full year will be in it. So we'll have a lot better view on that.
Got it that's very helpful and then what's the latest on film.
And any cancer all the details, but just curious what you can on a call like this regarding the timing of a potential sale that you think could happen. There and then also curious do you expect to receive any additional dividends for the next year or you know in the future.
Yeah, we're not we're not forecasting.
Dividends into next year, we're in the middle of a process.
And Youre right Theres not a whole lot more we can say about it but we feel good about where we are we have made progress and we're pushing hard.
So I made it a couple of comments in the prepared remarks, Kyle that we're not where we were at the beginning of the quarter. We were much more advanced but it is a complex process that back into the joint venture and not wholly owned when you look at the process for executing strategic options under these current guidelines by both governments that joint venture structure makes it more.
Time consuming and more complex process, but we we have advanced along that time that process timeline.
Quite a bit so im really pleased but we're not there to win there. So that's why we're not we're not.
Getting out over our skis on where we are on it but I feel really good about the amount of movement, we made through the quarter.
Got it thank you for all the details.
Thank you then I'd like to turn the call back over to Mark Sutton for closing comments.
Thank you operator, I'd just like to close by really saying, Thank you to all the international K for team members employees around the world.
They are doing everyday for our customers and what they are doing every day for each other.
Stay safe and to operate in environments that I don't think any of them ever thought they would be operationally to continue to do an outstanding job.
Just like to close.
By reiterating a couple of comments I made we think the second half of this year is clearly transitory.
We're taking the actions we need to take pulling the levers we need to pull to make sure international paper.
It gets through this period.
Very good way and I'm really pleased with the kind of financial underpinnings, we have entering into any type of economic environment, we have a lot of opportunity and flexibility even at lower demand levels and in some cases, there could be a silver lining in the fact that it allows us to get some of our supply chain.
This.
Function back into a proper alignment.
The strong balance sheet gives us options. So we can continue to make organic investments and structural cost reduction and in strategic capacity and capability in the past we would have probably had to stop some of that just to manage the balance sheet. There is no meaningful debt for the foreseeable future that we need to deal with so we've.
Got a lot of risk off the table. We're built for this type of environment and we're built for that for a strong environment.
And I feel good about our ability to get through it and look forward to talking to you with our full year call at the end of January So thank you for your interest in international paper.
Then ladies and gentlemen, thank you for your participation in international paper's third quarter 2022 earnings call you may now disconnect.
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