Q3 2024 Clearwater Paper Corp Earnings Call
Thank you for standing by and welcome to the Clearwater Paper 3rd Quarter 2024 Ernest Conference Call.
Speaker Change: All Line Heaven Placed On Me to prevent any background noise.
After the speakers are marked, there will be a question and answer session.
If you'd like to ask a question during this time, simply press star, followed by the number 1 on your telephone keypad. If you would like to withdraw your question, again, press the star 1. Thank you. I'd now like to turn the call over to Mr. Sloan Bohlen, Best Relations. You may begin.
Sloan Bohlen: Thank you Rob and good afternoon and thanks everyone for joining Clearwater Paper's third quarter 2024.
Sloan Bohlen: Ernings Conference Call, joining me on the call today, or Arsen Kitch, President and Chief Executive Officer and Sherri Baker, Senior Vice President and Chief Financial Officer.
Sloan Bohlen: An answer results for the third quarter 2024 release shortly after today's market close along with the filing of our 10Q, you will find a presentation of supplemental information including a slide provided in the company's career and outlook posted on the investor relations page of our website at clearwaterpaper.com.
Sloan Bohlen: Additionally, we will be providing certain non-gap information in this afternoon's discussion, a reconciliation of the non-gap information to comparable gap information included in the press release and in the sub-medal information provided on the website.
Sloan Bohlen: Please note, so I do have the supplement on information covering forward-looking statements. Rather, rereading that slide, we're going to incorporate it by reference into our prepared remarks. And with that, let me turn the call over to Arsen.
Arsen: Thank you for joining us today and good afternoon. Given our recent strategic announcements, I'm going to start my comments with a few highlights for the third quarter and then spend the bulk of my time discussing our industry fundamentals, our strategy, and what you can expect from us in the long run.
Sloan Bohlen: will then cover a third quarter results as well as our financial outlook, including initial expectations for 2025.
Sloan Bohlen: Let's start with a few highlights. We had a very good third quarter overall, delivering $64 million of adjusted EBITDA. This was in the middle of our guidance range of 58 to 68 million.
Sloan Bohlen: We would have been above the high end of the range, without the approximately $5 million of negative impact from Hurricane Helene, which affected our gut to Georgia, for the people, for facility, as well as the Shelby North Carolina tissue mill.
Sloan Bohlen: The Augusta facility was down to roughly six days, but there was no significant damage to our equipment.
Sloan Bohlen: As you saw in our press release last Friday, we closed on the sale of a tissue business on November 1st. As a reminder, we sold this business to Saffa Delphor $1.06 billion.
Sloan Bohlen: We expect to net approximately $850 million in cash from the sale after taxes and other customer expenses.
Sloan Bohlen: and we use the proceeds to pay down all our outstanding credit facilities.
Sloan Bohlen: We retained our 20-28 notes with an outstanding principle balance of 275 million and a rate of 4.75%. Finally, our board approved a $100 million share, reports us for a gram. We intend to buy back shares when they trade at a sufficient discount to what we believe to be our inherent value.
Sloan Bohlen: Now let's turn to an overview of our strategy.
Sloan Bohlen: With a sale of a tissue business, we're transforming clear water into a premier paperboard packaging supplier, focused on servicing independent converters in North America.
Sloan Bohlen: We're now able to sharpen our focus on growing and improving our paperboard business.
Sloan Bohlen: We will do this by driving operational and cost improvements, as well as finding ways to become more relevant to our customers by expanding our product range.
Sloan Bohlen: To put our strategy into perspective and to address many of the questions that we get from Sherri holders, I'll share our view on the paperboard industry structure and how we fit in.
Sloan Bohlen: We compete in an approximately 10 million ton North American paperboard market, which is made up primarily of three substrates. The first and the largest of the substrates is solid, bleached, sulfate, paperboard, or SBS.
Sloan Bohlen: There's approximately 5 million towns of SBS supply available in North America. This is the highest quality paperboard with superior print quality and performance, and is used primarily in consumer packaging and food service applications.
Sloan Bohlen: The second substrate is coated on bleach crap for CUK. In North America there's about 2.5 million tons of CUK supply. This substrate is known for its strength and is used primarily in beverage carrier applications, think, beer and soda packaging.
Sloan Bohlen: The third substrate is coated recycled board or CRB with approximately 2.5 million tons of supply in North America.
Sloan Bohlen: This is the only substrate that is made of recycled fiber and is used primarily in lower cost consumer packaging applications. A good end product example is a generic cereal box.
Sloan Bohlen: Paperboard demand has historically been relatively stable, showing only limited sensitivity to economic fluctuations.
Sloan Bohlen: Grove has historically tracked close to GDP and we believe that sustainability trends are a tailwind. As customers and consumers look to move away from plastics and towards renewable fiber-based packaging.
Sloan Bohlen: Supply has also been historically stable, but capacity changes come in large increments. For example, a new paper machine could have more than 500,000 tons of new capacity and cost worth of $500 million.
Sloan Bohlen: A single new machine can add nearly 10% to SBS industry supply and 20% to CUK or CRB.
Sloan Bohlen: In ports and exports of long plater oil in this industry, with approximately 2 million tons exported and 1 million tons imported annually. In ports fluctuate depending on market pricing in North America, shipping costs and supply and demand balances across the globe.
Sloan Bohlen: Well, imports have an impact on the market. North American convertors have shown a preference for the quality and security of domestic paperboards supply.
Sloan Bohlen: Let's now turn to industry structure. There are two kinds of paperboard suppliers. The first is an integrated supplier that manufacturers pay for board and convert that paperboard into packaging.
Sloan Bohlen: The second is an independent supplier that manufactures paperboard but has no downstream converting. Clear water is the latter, an independent supplier that is focused on servicing independent converters.
Sloan Bohlen: Integration rates vary by substrate, but we estimate that 55% of paperboard and North America is integrated, while 45% is non-integrated.
Sloan Bohlen: SPS is the least integrated of these substrates with an integration rate of approximately 30% based on our estimates.
Sloan Bohlen: While integrated suppliers have a state of strategy to increase their levels of integration, we believe that independent converters will continue to play a vital and long-term role in the market.
Sloan Bohlen: Independent converters offer agility, flexibility and a higher level of service than the integrated suppliers. They're more effective at servicing small to medium-sized customers and are often a critical secondary supplier to large CPG and food service companies that are unwilling to commit 100% of the business to large integrated players.
Speaker Change: Clearwater has a strong position within this industry structure. We have an excellent geographic footprint with our Lewiston, Idaho mill covering the western part of the U.S., our Cypress Bend, Arkansas mill covering the central part of Arkansas.
Sloan Bohlen: Pasta, George and Mel covering the east
Sloan Bohlen: These mills have a capacity of approximately 1.4 million tons of SBS and can produce around 1.4 million tons of pulp.
Sloan Bohlen: We also have five sheeting and distribution facilities as part of our Manchester Industries business that provide additional services to some of our smaller customers.
Sloan Bohlen: Unknown Executive, Arsen Kitch, Sherri Baker
Sloan Bohlen: We believe that our assets are well invested and that we have a strong reputation in the industry for quality and service. We're dedicated to independent converters and have no channel conflict. We strive to create long-term strategic partnerships with converters that drive growth for both sides.
Sloan Bohlen: Let's continue by discussing our point of view on the cyclicality of our industry. We operate in an inherently cyclical industry, driven by the supply and demand balance.
Sloan Bohlen: With demand being relatively stable and growing, this balance is largely driven by changes in supply.
Sloan Bohlen: In a down cycle, capacity additions outpace demand growth, resulting in industry utilization rates below 85% with falling margins.
Sloan Bohlen: This part of the cycle can lead to high cost assets being uncompetitive and not reinvestable.
Sloan Bohlen: At the midpoint of the cycle, which is typically the steady state of our industry, supply and demand are balanced with utilization rates of 90 to 95 percent. Margins at this part of the cycle are healthy and allow for reinvestment in the business.
Sloan Bohlen: In an upcycle, demand exceeds supply, with utilization rates exceeding 95%, leading to better margins.
Sloan Bohlen: This can lead to additional capacity being added and more imports.
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Sloan Bohlen: SPS is currently in a down cycle for two reasons. First, COVID drove unprecedented demand growth in SPS, followed by inventory de-stocking and a slowdown in consumer spending.
Sloan Bohlen: In addition, there's new SPS capacity announced for 2025, which is likely to continue this down cycle until there's a better supply and demand balance in the industry.
Sloan Bohlen: Even as we experience the cyclical downturn, we remain confident in long-term industry fundamentals of paperboard packaging in North America. And we believe that we're well-positioned for growth, given our customer preferences and consumer-driven sustainability trends.
Sloan Bohlen: I'd like to circle back to focus on our strategy and potential next steps for growth. As I mentioned earlier, we're transforming Clearwater into a premier independent supplier of paperboard packaging products to North American converters.
Sloan Bohlen: We've taken two big steps this year to execute that strategy with the acquisition of the Augusta SBS facility and the sale of our tissue business.
Sloan Bohlen: The proceeds from the tissue sale have been used to significantly deliver our balance sheet. With our strong balance sheet, we believe that we're well positioned to weather the current SPS down cycle, continue to invest in our assets, and broaden our product offering.
Sloan Bohlen: Whether through organic investments in our existing network or opportunistic acquisitions.
Sloan Bohlen: Given consumer preferences for fiber-based packaging, we see significant growth potential that requires innovation and investment.
Sloan Bohlen: In particular, we're looking to address three market trends. First, customers are interested in lighter weight paperboard options without sacrifice, sacrificing print quality and strength. Second,
Sloan Bohlen: Customers are looking for compostable solutions.
Sloan Bohlen: particularly in food service. This requires innovation and barriers and coatings to make them biodegradable.
Sloan Bohlen: And third, customers are interested in the inclusion of alternative fibers and paperboards, such as post-consumer recycled content.
Sloan Bohlen: Practically speaking, we're not looking at greenfield builds. Let me get a bit more specific and provide some examples of the internal projects that we're exploring.
Sloan Bohlen: We're looking at investments to increase the amount of mechanical and recycled pulp that we can consume on our paper machines. This can help us deliver a lighter weight sheet that competes with imported folding box board as well as a viable alternative to some of the higher quality CRB offerings.
Sloan Bohlen: We're also exploring adding unbleached pulping capabilities to diversify our product offering and deliver a beverage carrier grade that effectively competes with CUK.
Sloan Bohlen: We'll continue to invest in our Nuvo and Remagine brands, which are high-quality folding card and cup offerings with up to 35% post-consumer recycle content.
Sloan Bohlen: We're developing biodegradable barriers and coatings to deliver a compostable solution to our customers. These are just some of the options that we're assessing to diversify and grow our business.
Sloan Bohlen: In addition to internal investments, we will consider opportunistically acquiring assets that are a good fit for our network. We recognize that these acquisition opportunities are infrequent and difficult to predict.
Sloan Bohlen: Let me wrap up my comments by summarizing what you can expect from us through the industry cycle. In a down cycle, we're targeting adjusted EBITDA margins around 8-10%, and up to a 20% adjusted EBITDA to free cash flow conversion ratio.
Sloan Bohlen: In an upcycle, we expect adjusted EBITDA margins to exceed 16%, with a 60-70% free cash flow conversion ratio.
Sloan Bohlen: across the cycle.
Sloan Bohlen: We're targeting adjusted EBITDA margins of 13-14% and a 40-50% free cash flow conversion ratio.
Sloan Bohlen: At a 90-95% utilization rate, this assumes revenues of approximately $1.8 billion and includes the capture of Augusta synergies, which are primarily volume-driven.
Sloan Bohlen: Unknown Executive, Arsen Kitch, Sherri Baker
Sloan Bohlen: These assumptions translate into more than $100 million of annual free cash flows across the cycle.
Sloan Bohlen: Based on our cross cycle expectations, we expect our business to generate significant free cash flows in the long run, giving us the opportunity to create value through investments or returning capital to shareholders.
Speaker Change: With that, Sherri is going to discuss our third quarter results, our outlook and capital allocation priorities moving forward.
Sherri Baker: Thank you, Arsen. As Arsen mentioned earlier, we had a very good third quarter with adjusted EBITDA at $64 million.
Sherri Baker: The impact from Hurricane Helene was around 5 million. Without the hurricane, we would have been above the high end of our guidance range of 58 to 68 million.
Sherri Baker: Paperboard delivered $42 million of adjusted EBITDA in the third quarter, up from $11 million in the second quarter, but down from $53 million last year. Sequential results improved with one additional month of Augusta operations and lower major maintenance outage impact.
Sherri Baker: Year-over-year results were down largely due to market pricing.
Sherri Baker: Demand recovery continues with AFMPA reporting industry SPS shipments up 2.4% in Q3 of this year versus the prior quarter and up 2.5% year-to-date 2024 versus 2023.
Sherri Baker: Our customers are also telling us that they are optimistic about growth in 2025. While we believe that a recovery is underway, industry shipments remain below pre-COVID levels with a continued recovery expected into 2025 and 2026.
Sherri Baker: Tissue delivered 41 million of adjusted EBITDA in the third quarter, flat versus the second quarter, and up slightly versus last year. The team again delivered strong operating performance, offsetting pulled headwinds.
Sherri Baker: Shipments grew as private brands continued to gain share, hitting 38% in the third quarter. As a reminder, we will have one month of tissue results in our fourth quarter, after which we'll be reporting on a paperboard-only business.
Sherri Baker: Let's now turn to our outlook for the fourth quarter as compared to the third quarter. With only one month of tissue in the fourth quarter, we expect to have $25 to $30 million less adjusted EBITDA due to the sale of that business.
Sherri Baker: We have a major maintenance outage planned in Augusta in the fourth quarter, which we estimate will cost us approximately $15 to $20 million.
Sherri Baker: Partly offsetting both is that we will not have a maintenance outage impact at our Lewiston Mill and expect improved operating performance.
Sherri Baker: With these key variables and assumptions, we are expecting $20 to $30 million of adjusted EBITDA in the fourth quarter.
Sherri Baker: Unknown Executive, Arsen Kitch, Sherri Baker
Sherri Baker: Beyond the fourth quarter, we are targeting an adjusted EBITDA margin of 8 to 10% in 2025.
Sherri Baker: This assumes the following, a continued demand recovery, but with SPS in a continued down cycle as the industry absorbs new capacity that is announced to come online in 2025.
Sherri Baker: We currently estimate that our capacity utilization rates will be around 85%, which will translate into approximately $1.5 to $1.6 billion of revenue.
Sherri Baker: To help offset this, we will reduce our overall fixed cost structure by approximately 10% and target a 6% SG&A spend as percent of sales. These actions should translate into more than $50 million of annual run rate cost savings by the end of 2025.
Sherri Baker: As previously announced, we will move to an annual major maintenance outage cadence at all of our mills.
Sherri Baker: We expect to incur $40 to $50 million of direct major maintenance expenses next year, with the bulk of spending taking place in Lewiston in Q2 and Augusta in Q4. This annual cadence is expected to lead to smaller, less costly, and more predictable outages.
Sherri Baker: We are also expecting this cadence to improve our overall operating performance and reliability.
Sherri Baker: Unknown Executive, Arsen Kitch, Sherri Baker
Speaker Change: As Arsen mentioned, we are confident about the long-term prospects for our company and we expect the market cycle to recover once supply and demand comes back into balance.
Speaker Change: Across the cycle, we are targeting to deliver 13 to 14% adjusted EBITDA margin, which should translate into a 40 to 50% free cash flow conversion ratio and more than $100 million in annual free cash flows.
Sherri Baker: While we cannot predict the exact timing of recovery, we will actively manage our cost structure to reflect the current market reality.
Sherri Baker: I'll wrap up my comments with a brief discussion of our capital allocation philosophy.
Speaker Change: Unknown Executive, Arsen Kitch, Sherri Baker
Sherri Baker: First, our goal is maintaining and improving the performance of our assets, which will require approximately $70 to $80 million of annual maintenance capital. This excludes large strategic or replacement projects, which could add another $10 to $20 million per year on average over the long term.
Sherri Baker: Please note that these additional expenditures are episodic and come in large increments. We will communicate these large projects ahead of time, just like we did with the Recovery Boiler Project in Lewiston and the Emissions Project in Cypress Bend.
Sherri Baker: Second, we aim to maintain a strong balance sheet with a net leverage ratio of 1-2 times through the cycle. This is lower than our previous target of 2.5 times given our smaller size and a single segment cyclical business.
Sherri Baker: We may temporarily go above that range for strategic reasons or below that range to provide us with flexibility.
Sherri Baker: Third, we aim to reinvest capital into our business or return it to shareholders, depending on which option provides the best return.
Sherri Baker: Reinvesting in the business may include organic investments or M&A. Returning capital to shareholders will most likely come through share repurchases such as the one that we announced today.
Sherri Baker: With that, I'll pass it back to Arsen for closing remarks.
Arsen Kitch: With the sale of tissue, we're strengthening our position as a premier and dependent supplier of paperboard packaging products to North American converters.
Arsen Kitch: We have a well invested asset base and a strong reputation for service and quality. We have a strong history of supporting our independent customers regardless of market conditions and we're committed to helping them win.
Arsen Kitch: We continue to strengthen the sustainability of both the products we produce and how we produce them.
Sherri Baker: We're optimistic about the medium to long-term prospects for our industry and our company.
Sherri Baker: As a result, we expect strong margins and cash flows through the cycle and aim to strategically deploy capital to create long-term shareholder value.
Sherri Baker: Finally, I'd like to thank all our people for their efforts to remain focused on operating safely and providing excellent service to our customers during this time of transition.
Sherri Baker: I'd like to especially thank our tissue team for building an outstanding business and managing through this time of change.
Sherri Baker: With that, we'll open it up to your questions.
Speaker Change: Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star one on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your question, simply press star one again. Your first question comes from a line of Matthew McKellar from RBC Capital Markets. Your line is open.
Matthew Mckellar: Hi, good afternoon. Thanks for taking my questions. Appreciate all the detail with results and congratulations on closing the tissue sale.
Speaker Change: Thank you, Matt. Certainly, you talked about potential investments, potentially using more mechanical and recycled pulp consumption, I believe, to arrive at a lighter weight product.
Speaker Change: to compete with Folding Boxboard.
Speaker Change: Can you just provide a bit more color on what these investments would mean in terms of dollars and timelines and then maybe more broadly speak to what a lightweight product in the portfolio would mean for your ability to meet customer preferences and potentially drive higher utilization levels of time? Thanks.
Speaker Change: Thanks.
Speaker Change: Good questions, Matt. I think there's two questions in there.
Speaker Change: One is around the scale of these of these investments.
Sherri Baker: you know, from a from including these types of additional pulps into our system. I would say these are small to medium sized investments. I won't give a specific number out there, but, you know, measured and
Sherri Baker: In millions of dollars, it's essentially improving our pulpers to make sure that we can add these pulp streams into our paper machines.
Sherri Baker: So these, these particular projects aren't aren't massive in nature folding folding box board offers a lighter weight product and it does have some trade offs on performance so it can include up to
Sherri Baker: you know, 30% or more of this mechanical pulp. We are looking at products that include mechanical pulp, but maintain the quality of SBS. So our goal is to deliver a
Sherri Baker: a lighter weight product that matches the current quality and printability of SBS. I hope that helps.
Sherri Baker: Unknown Executive, Arsen Kitch, Sherri Baker
Speaker Change: Yeah, that's great. And maybe to kind of follow up on that one. I think there is a comment to about
Speaker Change: an unbleached product that would potentially compete with CUK. Would this be to take advantage of, I guess, a spread in price that kind of exists between CUK and SBS or?
Sherri Baker: You also see CUK is growing faster over time and then when you have the ability I guess to pivot and swing production back and forth potentially between grades.
Sherri Baker: Unknown Executive, Arsen Kitch, Sherri Baker
Speaker Change: Yeah, we're in an exploratory stage on this.
Sherri Baker: There is not much of a CUK supply to the independent market, so we see an opportunity with that offering. Again, we're exploring that grade. It's a way for us to diversify our...
Sherri Baker: our production mix, especially at some of our at some of our facilities where, you know, geographically, we may have we may have an advantage. So we're we're in exploratory stages of that more on that to come. We just wanted to provide a provide a flavor of the types of things we're looking at.
Sherri Baker: Unknown Executive, Arsen Kitch, Sherri Baker
Speaker Change: Okay, thanks. That's that's helpful.
Speaker Change: Switching gears here on your actions to reduce fixed costs. Could you maybe just provide a bit more color on kind of
Speaker Change: You know, what the major items might be there and what your expectations are around cadence of those cost savings being realized through, you know, either the balance of 24 and probably through 25 in particular, please.
Speaker Change: Unknown Executive, Arsen Kitch, Sherri Baker
Speaker Change: Yeah, so what we mentioned is two things. We're going to be targeting about a 10% fixed cost reduction and getting SG&A to about 6% of net sales.
Speaker Change: So we're targeting 50 plus million of annual life savings.
Speaker Change: Oh, again, we're in the planning stages of that. So I don't want to commit to a specific cadence. But but fair to say we
Speaker Change: We want to capture as much of those of those savings as possible next year, you know, thinking maybe as high as 30 to $40 million next year of savings that are baked into our 2025 outlook.
Speaker Change: Unknown Executive, Arsen Kitch, Sherri Baker
Speaker Change: Okay, that's helpful. And around your outlook, I think on the last call, you talked about maybe potentially taking some price in cup and plate stock. Can you provide any color on how successful that was? What in price improvements, if any, may be embedded in your expectations for Q4 in 2025?
Speaker Change: Matt, we shy away from from commenting on on on pricing actions and on earnings call. So, we'll, we'll, we'll stay away from that. I think it's our best. Our expectations are embedded into our into our Q4 guidance as well as the 2025 outlook. I think what we mentioned.
Speaker Change: is approximately 40 to $50 million of negative price cost impact next next year, so that's between price price and cost. And I think that accounts for what we see as a as a continued continued down cycle in SPS.
Speaker Change: Okay, thanks. That's helpful. And last one for me.
Speaker Change: Just on the hurricane and maybe the port strikes. I think he talked about it. In fact, compelling to your
Speaker Change: Q3 results. Should we think about there being an impact embedded in your Q4 guide as well? Apologies if I missed that.
Speaker Change: and then around the short-lived port strikes in the East Coast. Do those drive any sort of disruption in the paperboard market that we should be thinking about? Probably just around Q4 specifically. Thanks.
Speaker Change: Unknown Executive, Arsen Kitch, Sherri Baker
Speaker Change: Unknown Executive, Arsen Kitch, Sherri Baker
Speaker Change: Yeah, Matt, I can answer that. So on the hurricane, the five million was specific to the Q3, you're probably looking at another two to three million in the fourth quarter, which would be embedded in our guidance and no impact from any of the labor issues that were going on in the ports. So no impact to us from that.
Speaker Change: Okay, thanks very much. I'll turn it back.
Speaker Change: Unknown Executive, Arsen Kitch, Sherri Baker
Speaker Change: If you'd like to ask a question, press star one on your telephone keypad.
Speaker Change: Unknown Executive, Arsen Kitch, Sherri Baker
Speaker Change: And there are no further questions. This does conclude today's conference call. Thank you for your participation. You may now disconnect.
Speaker Change: Unknown Executive, Arsen Kitch, Sherri Baker