Packaging Corporation of America (NYSE:PKG) Q4 2022 Earnings Call Transcript

Packaging Corporation of America (NYSE:PKG) Q4 2022 Earnings Call Transcript January 26, 2023

Operator: Good day, everyone. Thank you for joining Packaging Corporation of America’s Fourth Quarter and Full Year 2022 Earnings Results Conference Call. Your host will be Mark Kowlzan, Chairman and Chief Executive Officer of PCA. Upon conclusion of his narrative, there will be a question-and-answer session. Please also note today’s conference call is being recorded. At this time, I’d like to turn the call over to Mr. Kowlzan. Please proceed when you are ready.

Mark Kowlzan: Thank you, Jamie. Good morning, and thank you all for participating in Packaging Corporation of America’s Fourth Quarter and Full Year 2022 Earnings Release Conference Call. Again, I’m Mark Kowlzan, Chairman and CEO of PCA. And with me on the call today is Tom Hassfurther, Executive Vice President, who runs our packaging business; and Bob Mundy, our Chief Financial Officer. I’ll begin the call with an overview of our fourth quarter and full year results, and then I’m going to be turning the call over to Tom and Bob, who’ll provide further details. And then I’ll wrap things up, and we’d be glad to take questions. Yesterday, we reported fourth quarter 2022 net income of $212 million or $2.31 per share. Excluding special items, fourth quarter 2022 net income was $215 million or $2.35 per share compared to the fourth quarter of 2021 net income of $262 million or $2.76 per share.

Fourth quarter net income — fourth quarter net sales were $1.98 billion in 2022 and $2.04 billion in 2021. Total company EBITDA for the fourth quarter, excluding special items, was $409 million in 2022 and $463 million in 2021. Excluding special items, we also reported full year 2022 earnings of $1.04 billion or $11.14 per share compared to 2021 earnings of $894 million or $9.39 per share. Net sales were $8.5 billion in 2022 and $7.7 billion in 2021. Excluding special items, total company EBITDA in 2022 was $1.9 billion compared to $1.7 billion in 2021. Fourth quarter and full year 2022 net income included special items primarily for certain costs at the Jackson, Alabama mill for paper to containerboard conversion-related activities. Details of all the special items for the year 2022 and 2021 were included in the schedules that accompanied the earnings press release.

Excluding special items, the $0.41 per share decrease in fourth quarter 2022 earnings compared to the fourth quarter of 2021 was driven primarily by lower volumes in our Packaging segment $1.14 and Paper segment $0.02. We also had higher operating costs of $0.48, primarily from inflation on energy, chemicals, labor and benefits, supplies, repair materials and services and other indirect and fixed costs. Freight and logistics expenses were unfavorable $0.13 along with higher depreciation expense, $0.09, higher converting costs, $0.06 and higher scheduled maintenance outage expenses of $0.01. These items were partially offset by higher prices and mix in the Packaging segment of $1.18 and Packaging segment — and Paper segment rather of $0.21.

A lower share count resulting from share repurchases $0.08; lower interest expense, $0.04 and a lower tax rate, $0.01. Results were $0.13 above the fourth quarter guidance of $2.22 per share, primarily due to higher prices and mix in the Packaging segment, lower freight and logistics expenses, a lower share count resulting from share repurchases and a lower tax rate. Looking at our Packaging business. EBITDA, excluding special items in the fourth quarter of 2022 of $392 million with sales of $1.8 billion resulted in a margin of 21.7% versus last year’s EBITDA of $461 million and sales of $1.9 billion or a 24.5% margin. For the full year 2022, Packaging segment EBITDA, excluding the special items, was $1.8 billion with sales of $7.8 billion or a 23.8% margin compared to full year 2021 EBITDA of $1.7 billion with sales of $7.1 billion or a 23.9% margin.

Demand in the Packaging segment was below expectations for the quarter, causing us to run our containerboard system to these lower demand levels. Our employees did a very good job with their cost management and process optimization efforts at these lower production rates to offset the negative volume impact. Total economic-related downtime for the fourth quarter was approximately 231,000 tons. The scheduled maintenance outage and conversion work at our Jackson, Alabama mill was completed successfully during the fourth quarter, and we restarted the mill earlier this month after being down as a result of the lower demand. The number three machine achieved its first phase design capacity and is producing a very high-quality virgin linerboard. However, based on current containerboard demand levels, we decided to move the second phase of the conversion work from this spring to next year in 2024.

I’ll now turn it over to Tom, who will provide further details on containerboard sales and the corrugated business.

Thomas Hassfurther: Thank you, Mark. Domestic containerboard and corrugated products prices and mix together were $1.19 per share above the fourth quarter of 2021 and flat compared to the third quarter of 2022. Export containerboard prices and mix were down $0.01 per share compared to the fourth quarter of 2021 and down $0.02 per share compared to the third quarter of 2022. Corrugated product shipments were down 8.7% per work day and down 10.2% in total with 1 less workday compared to last year’s fourth quarter. Outside sales volume of containerboard was 131,000 tons below last year’s fourth quarter and 38,000 tons below the third quarter of 2022. The lower demand in our Packaging segment was driven by several items. The inventory correction in both boxes and our customers’ product has been more prolonged than what we originally anticipated at the start.

Inflationary pressures on the consumers have also added to the problem by reducing the consumers discretionary spending capabilities. In addition, consumer behavior changed very quickly as we exited the extreme COVID period, resulting in more of a preference towards travel, entertainment and experience versus that of tangible goods. Containerboard and box demand continues to be negatively impacted from the deterioration in U.S. and global economic conditions, rising interest rates and a cooler housing market. As we move from the fourth quarter into the first quarter, we estimate the rate of shipments per day to be fairly similar as we expect many of these conditions to continue. However, there are 4 additional shipping days in the first quarter, so total actual shipments will be higher when compared to the fourth quarter of 2022.

In spite of the numerous issues currently impacting demand, we continue to perform at levels above pre-COVID and anticipate our first quarter shipments to exceed first quarter 2019 shipments by approximately 6% on a per day basis. Now I’ll turn it back to Mark.

Mark Kowlzan: Thanks, Tom. Looking at our Paper segment. EBITDA, excluding special items in the fourth quarter was $39 million with sales of $154 million or a 25.7% margin compared to the fourth quarter of 2021 EBITDA of $26 million on sales of $143 million or an 18.4% margin. For the full year 2022, Paper segment EBITDA, excluding special items, was $132 million with sales of $622 million or 21.3% margin compared to the full year 2021 EBITDA of $72 million with sales of $600 million or a 12% margin. Prices and mix were up 21% from last year’s fourth quarter and moved 3% higher from the third quarter of 2022 as we continue to implement our previously announced price increases. Sales volume was about 11% below last year’s fourth quarter, primarily due to paper sales from the Jackson Mill’s #1 machine, which we included in last year’s results as well as having — we optimized our product and customer mix since that time as we transitioned away from paper volume at Jackson mill.

As expected, volume was down approximately 11% versus the seasonally stronger third quarter of 2022 and that also included the remaining inventory from the Jackson mill. The management team and all of the employees of the Paper business have done a tremendous job over the last several quarters to optimize our inventory, product mix and cost structure in order to deliver outstanding results for 2022, and I’m confident that we can maintain this momentum through 2023. I’ll now turn it over to Bob.

Robert Mundy: Thanks, Mark. Cash provided by operations during the quarter totaled $420 million with capital expenditures of $247 million and free cash flow of $173 million. Other cash payments during the fourth quarter included dividend payments of $116 million, cash tax payments of $56 million and net interest payments of $31 million. We also spent $380 million during the quarter to repurchase just over 3 million shares of our common stock at an average price of $126.70 per share. That brings our total repurchases, over the last 5 quarters, to almost 5.5 million shares at an average price of $130.62 per share. Repurchases of our outstanding stock and dividend payments made during the past year, represent 63% of cash from operations or 91% of net income that was returned to shareholders in 2022.

For the full year 2022, cash from operations was $1.5 billion. Capital spending was $824 million, with free cash flow of $671 million. Our final recurring effective tax rate in 2022 was 24.5%, and our final reported cash tax rate was 20%. Regarding full year estimates of certain key items for the upcoming year, we expect total capital expenditures to be approximately $475 million, and DD&A is expected to be approximately $485 million. We estimate dividend payments of $450 million and cash pension and post-retirement benefit plan contributions of $53 million. Our full year interest expense in 2023 is expected to be approximately $72 million and net cash interest payments should be about $74 million. The estimate for our 2023 book effective tax rate is 25%.

Currently, planned annual maintenance outages at our mills in 2023, including lost volume, direct costs and amortized repair costs, it’s expected to be in total, $0.67 per share versus $0.99 per share in 2022. The current estimated impact by quarter in 2023 is $0.11 per share in the first quarter, $0.14 in the second, $0.22 in the third and $0.20 per share in the fourth quarter. I’ll now turn it back over to Mark.

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Mark Kowlzan: Thank you, Bob. The hard work of our employees, along with strong relationships between us and our customers and suppliers delivered outstanding results for PCA in 2022. New annual company records were achieved for revenue, cash from operations, net income and earnings per share. And as Bob just mentioned, 91% of our net income was returned to our shareholders from dividend payments and stock repurchases. We successfully completed or substantially completed significant cost reduction and process improvement projects at our mills including a 30-megawatt steam turbine and first phase of the #3 machine conversion to containerboard at the Jackson mill. This effort included fiber flexibility projects at the Wallula and Jackson Mills and many other key initiatives.

We also completed numerous high return and high efficiency improvement projects in our corrugated products plants that will allow us to better optimize our entire packaging business for the future and deliver profitable growth and mix enhancement opportunities for our customers and shareholders. The significant capital investments we’ve made during the year had complete involvement of PCA personnel from project conception, preliminary and detailed engineering, all the way through to project implementation and start-up. These projects and initiatives achieved numerous tactical and strategic benefits while improving our industry-leading return on invested capital to just under 20%. As we’ve discussed on these calls many times before, by the end of 2022, we would be winding down several years of significant strategic capital investments that position us very well to meet the future needs of our many customers in a very cost-effective manner.

We also finalized the optimization of our paper business while delivering excellent financial results that we expect to sustain us well into the future. As economies around the world continue to deal with numerous issues and uncertainties, virtually every individual industry is being negatively impacted in some manner. At PCA, we will continue to maintain a strong balance sheet which provides the financial flexibility to react quickly to most situations or opportunities in the future. We will also continue our commitment of a balanced approach towards capital allocation in order to maximize our profitability and returns to our shareholders. Looking ahead, as we move from the fourth and into the first quarter in our Packaging segment, as Tom mentioned, we expect box demand on a per day basis to be similar to the fourth quarter levels, although we expect higher total volume with corrugated products plants having 4 additional shipping days.

Prices will move lower as a result of recent decreases in the published domestic containerboard prices and we’re assuming lower export prices as well. Paper prices should move slightly higher with sales volume fairly flat. Labor costs and certain indirect costs will increase as some containerboard mill operations were temporarily idled during the fourth quarter. In addition, we anticipate higher labor and benefits costs and other timing-related expenses that occurred at the beginning of a new year as well as higher prices for many chemicals, particularly starch and caustic soda. However, we expect lower wood and recycled fiber prices, lower energy prices and lower scheduled maintenance outage expenses. Lastly, we expect higher interest and nonoperating pension expenses and a higher tax rate, but we will see some benefit from our recent share repurchases.

Considering these items, we expect first quarter earnings of $2.23 per share. With that, we’d be happy to entertain any questions, but I must remind you that some of the statements we’ve made on the call constituted forward-looking statements. The statements were based on current estimates, expectations and projections of the company and involve inherent risks and uncertainties, including the direction of the economy and those identified as risk factors in our annual report on Form 10-K and in subsequent quarterly reports on Form 10-Q filed with the SEC. Actual results could differ materially from those expressed in the forward-looking statements. And with that, Jamie, I’d like to open the call for questions, please.

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Q&A Session

Operator: . Our first question today comes from George Staphos from Bank of America Securities.

George Staphos: Thanks for the details. Congratulations on very good performance in a very, very challenging quarter, at least from our estimation. Mark, my first question, to the extent that you can comment, you took a significant amount of downtime. Production was down sharply, from our own rough calculations it would seem like your inventories now are fairly well balanced relative to your needs, but if you had to qualitatively talk to them, would you say your inventories are normal, below normal, above average? How would you have us think about that?

Mark Kowlzan: Well, again, it depends on what time period you’re looking at. We’re living in a dynamic world right now. And if you went back to 2020, let’s go back and take a look at what happened there, as the pandemic settled in, and we got into the fall of 2020, and demand picked up dramatically in that period of time, we found ourselves at, quite frankly, an unsustainably low level of inventory per our demand. And it took us the better part of 2021 to drive that inventory to a much more comfortable level. Obviously, part of that was the transportation dilemma that was taking place throughout North America between truck drivers availability and rolling stock availability with the pandemic going on. And then just the demand pressures that were in place.

But through the end of 2021 into the early part of 2022, we did achieve the — what we felt were comfortable levels of inventory to supply our system. As the year 2022 rolled on, we also anticipated certain end-of-year activities with annual outages through the year and then different marketplace conditions into the third and fourth quarter. What we saw happen, obviously, in the fourth quarter was the falloff in demand and so we were able to readjust what we didn’t believe should be our new inventory targets understanding that demand was falling off faster than we had anticipated. But also, we had the capacity now with our system improvements and with the Jackson mill being completed that we had a much higher comfort level that we could supply outside sales and our own box plant needs by running to a lower level, which again was a prudent financial decision for us.

Anything else, George?

George Staphos: A couple more, I’ll make them quick. The mix given our calculations was quite strong. Is there one thing you would point out or a couple of things you’d point out in terms of what allowed you to put up some fairly strong realizations per ton realizing quarter-to-quarter things can move around. And the same thing on operations and cost if there was one or 2 things, you had to point out that allows you to put up the quarter that you did. What were the 2 highlights be? Then I’ll turn it over there.

Mark Kowlzan: I’ll let Tom talk about the mix question then I can talk about operations.

Thomas Hassfurther: Yes. Well, our mix was solid again, George. Of course, we don’t — with 18,000-plus customers spread across a lot of different industries, it was a relatively strong mix, and we were pleased with that. And I would just — Yes, go ahead.

George Staphos: So is that more execution than, Tom, as opposed to any one driver? Is that what you’re kind of getting at there?

Thomas Hassfurther: Yes, yes, I think so. And Mark will talk a little bit more about the cost side. But I think we’re also seeing some big benefits from all the investments that we’ve made, especially in our box plants over the past number of years. And so from a cost basis, we were incredibly good and performed very well.

Mark Kowlzan: To that point, George, in 2021, with the new organization that we put in place in 2019, and we’ve been doing all of these capital projects in the mills and box plants. But 2021, we worked on probably 53 of our box plants with various sized capital projects going on from big projects and — to small projects for retooling, recapitalizing converting lines, corrugating operations, significantly improving the unit labor productivity in these facilities. Same thing in the mills we’ve worked for decades, and we continue to do that every day on improving the efficiencies throughout the operations. And so that was another thing. I think if you look at the cumulative benefit of what Tom just said with the projects that we put in place in the box plants, the ongoing efforts that we continue to perform in our mills, we were able to pivot during the latter part of the year.

And even though we took machines down and idled the Jackson mill, we’re able to really wring out some efficiencies because of how we operate day-to-day and how we understand where these opportunities are. Again, it’s — it reflects on the organization and how we look at our business 24 hours a day, 7 days a week.

Operator: And our next question comes from Mike Roxland from Truist Securities.

Michael Roxland: Just on Jackson, how do you plan to operate that mill going forward? Obviously, the first phase is behind you. You’ve postponed now the second phase to 2024. Given that demand remains challenging, as you’ve noted, you operate that convert line? And do you have the flexibility if the manner remains challenging to operate white paper on it given still strong line paper markets?

Mark Kowlzan: No, the Jackson mill now is a containerboard operation. That mill, for all intents and purposes, will not make any white paper ever again. It’s truly the work we just completed in terms of the scope of work that we set out has achieved everything that the first phase was supposed to. We are now running very efficiently, very effectively. We started up just the week before last, and we ran last week, and we’ve been producing Grade A paper converting it in our box plants, but we’ll be able to take advantage now of the project’s cost benefit opportunities. There’s the work that was done, and we talked about this last year would help us on the input cost side of the equation with energy usage, labor-type impacts, fiber yield, and so we will see those benefits.

Now it depends also on how much production we see on the big machine. We’re also ramping up the machine as we speak. The machine for the last 1.5 years from when we converted it in 2021 and ran through 2022, we were producing probably 1,275 tons a day average in that range. And right now, currently, we’re somewhere in that 1,300-ton a day range and just getting comfortable with all of the new equipment. Essentially, we have a new paper machine on our hands here and then the pulp mill has been significantly rebuilt and new OCC plant. So there’s a lot of new infrastructure in the mill that we’re getting used to running, but we’re also going to look at what the opportunity is. The second phase of work that we can choose to do when the timing is right, involves 23 new additional high-pressure dryer cans, a new forset reel at the dry end of the paper machine and then a new shoe press in the press section to enhance pricing and improve the drawing.

That will take place when we need the tons. So that’s to be determined, but we have the luxury of deciding that when we need to decide that. But the first phase of the work has been done extremely well. We’re very pleased with what we see. So now we’ll take advantage of what we have in place. And as we’ve done for many years, we’ll wring out these benefits and these efficiencies from day to day here. So I’m pretty optimistic on what we have at Jackson. The #1 machine, the smaller machine is down. It’s idle temporarily. It will be available if demand determines that we should run that. And so again, I think current times, we will continue to run to demand. The entire system, we also have the annual outages coming up starting next month with our DeRidder and Counce mill.

So we have to think about where we need to be with inventory levels and what we have to do to supply our box plant needs. So in that regard, I think Jackson is in a good place, but a lot of opportunity there.