Earnings Call Transcript - PKG Q2 2024

Operator, Operator

Good morning. Thank you for joining Packaging Corporation of America's Second Quarter 2024 Earnings Results Conference Call. Your host today will be Mark Kowlzan, Chairman and Chief Executive Officer of PCA. Upon conclusion of his narrative, there will be a Q&A session. I will now turn the conference over to Mr. Kowlzan. Please proceed when you are ready.

Mark Kowlzan, CEO

Good morning, everyone and thank you for participating in Packaging Corporation of America's second quarter 2024 earnings release conference call. Again, I'm Mark Kowlzan, Chairman and CEO of Packaging Corporation of America. And with me on the call today is Tom Hassfurther, Executive Vice President, who runs the Packaging business; and Bob Mundy, our Chief Financial Officer. I'll begin the call with an overview of the second quarter results. And then I'll be turning the call over to Tom and Bob, who'll provide further details. And then I'll wrap things up and we'll be glad to take questions. Yesterday, we reported second quarter net income of $199 million or $2.21 per share. Excluding special items, second quarter 2024 net income was $199 million or $2.20 per share compared to the second quarter 2023 net income of $209 million or $2.31 per share. Second quarter net sales were $2.1 billion in 2024 and $2 billion in 2023. Total company EBITDA for the second quarter excluding special items, was $404 million in 2024 and $418 million in 2023. The details of special items for both the second quarter of '24 and 2023 were included in the schedules that accompanied the earnings press release. Excluding special items, the $0.11 per share decrease in second quarter 2024 earnings compared to the second quarter of 2023 was driven primarily by lower prices and mix in our Packaging segment for $0.87 and Paper segment $0.07. Even with our constant focus on minimizing inflationary cost increases, operating costs were higher by $0.31 per share. This was particularly in the areas of recycled fiber and inflation-driven increases on labor and benefits, outside service expenses, repair and operating material costs, rents, property taxes and insurance. We also had higher depreciation expense of $0.03 and a higher tax rate of $0.03. These items were partially offset by higher volume in the Packaging segment for $0.94 and Paper segment $0.07, lower other converting costs, $0.07, lower freight and logistics expenses, $0.06 and lower interest expense, $0.06. Looking at the Packaging business, EBITDA, excluding special items in the second quarter of 2024 of $400 million with sales of $1.9 billion resulted in a margin of 21% versus last year's EBITDA of $405 million and sales of $1.8 billion or a 23% margin. The strong market conditions in our Packaging segment continued in the second quarter. This drove a new all-time containerboard production record that was necessary in order to service the corrugated products and containerboard demand. Also, Packaging segment prices and mix moved higher from the first quarter levels as we continue to implement our announced price increases. Although still below target levels, we were able to build some inventory ahead of what we expect to be a very busy second half of the year. In our mills and corrugated products facilities, employees remain focused on efficient and cost-effective operations from thousands of initiatives as well as implementing the benefits and improvements from our capital spending strategy. I'll now turn it over to Tom, who will provide further details on the containerboard sales and corrugated business in general.

Tom Hassfurther, Executive Vice President

Thanks, Mark. Along with the record-setting containerboard production that Mark mentioned, corrugated products demand strengthened throughout the quarter and ended with a new shipments per day record for the month of June. In fact, we were just 0.1% away from our all-time second quarter total shipments record. Shipments per day were up 9.2% over last year's second quarter and total shipments with 1 additional shipping day were up 10.9%. Outside sales volume of containerboard was 42,000 tons above last year's second quarter and 35,000 tons above the first quarter of 2024. Segment prices and mix moved higher as we continue to implement our price increases from February which was negatively impacted by the late fourth quarter 2023 decrease reported by the RISI publication along with the more recent increase in June. Domestic containerboard and corrugated products prices and mix together were up $0.09 per share compared to the first quarter of 2024. However, they were $0.84 per share below the second quarter of 2023. Export containerboard prices were up $0.03 per share versus the first quarter and down $0.03 per share compared to the second quarter of 2023. Finally, some of you may have seen news about an investment we made in the Phoenix, Arizona area. In order to serve a growing market and to grow with our existing customers, we are in the process of replacing our current Phoenix corrugated products plant with a modern state-of-the-art facility. Like many of our strategic projects, the Phoenix project improves the capacity, technology and equipment in the plant gets us aligned properly in the right marketplaces addresses the needs of our customers so that we both grow profitably and improves the efficiencies and cost within our system. I'll now turn it back to Mark.

Mark Kowlzan, CEO

Thanks, Tom. Looking at our Paper segment. EBITDA, excluding special items in the second quarter was $31 million with sales of $150 million or a 20.4% margin compared to the second quarter of 2023 EBITDA of $39 million and sales of $143 million or a 27.2% margin. Paper segment prices and mix as well as volume came in as expected. And as we mentioned last quarter, although we are implementing our recently announced paper price increases, the published decrease in index prices earlier this year and how that impacts contract triggers with certain customers would initially delay the timing of realizing the increases. Overall, average prices and mix were essentially flat with the first quarter 2024 levels and down 5.6% versus the second quarter of 2023. Market conditions versus last year were solid with volume up 12% versus the second quarter of 2023 driven somewhat by the timing of seasonal back-to-school business. Volume was 8% below the first quarter of 2024, impacted by the scheduled maintenance outage at the International Falls, Minnesota mill as well as exceptionally strong volume in the first quarter. Similar to the comments I made regarding the packaging business, employees in the Paper business remain focused on very efficient and cost-effective operations and executed the outage at International Falls very well and slightly below our cost estimates. I'll now turn it over to Bob.

Bob Mundy, CFO

Thanks, Mark. Cash provided by operations during the quarter totaled $278 million and free cash flow was $33 million. The primary payments of cash during the quarter included capital expenditures of $245 million, dividend payments of $112 million, cash taxes of $100 million and interest payments of $37 million. Excluding the invested cash proceeds from the bond transaction, we will use to retire the $400 million bond that matures in September. Our quarter end cash balance, including marketable securities was approximately $800 million with liquidity of $1.1 billion. We mentioned on last quarter's call that today we would provide an update on our capital spending guidance. We are revising our full year guidance from a range of $470 million to $490 million to a range of $670 million to $690 million. The increase is primarily attributable to additional high-return, profitable growth and mix enhancement opportunities within our box plants as well as the new greenfield box plant in Phoenix that Tom spoke of. Spending for these projects fits in very well with our expected cash flow and balanced approach towards cash allocation in order to grow profitably our company and maximize returns to our shareholders. I'll now turn it back over to Mark.

Mark Kowlzan, CEO

Thank you, Bob. Looking ahead, as we move from the second quarter into the third quarter, prices and mix in both our Packaging and Paper segments will move higher as we continue to implement previously announced increases along with higher containerboard export prices. Although there is one less shipping day for the corrugated business, we expect shipments per day to continue to strengthen, potentially setting a new third quarter record. We also expect higher containerboard volume. With current containerboard inventory below our target levels, we will also attempt to build some inventory ahead of the scheduled maintenance outage at our DeRidder Mill in October. Paper volume will be slightly lower primarily due to timing of back-to-school business that was received in the second quarter. Operating and converting costs should be higher primarily due to seasonal electricity usage and prices and slightly higher recycled fiber costs with scheduled outage expense expected to be slightly lower. Considering these items, we expect third quarter earnings of $2.45 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 today constitute forward-looking statements. These statements are based on current estimates, expectations and projections of the company and do 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 which is on file with the SEC. Actual results could differ materially from those expressed in the forward-looking statements. And with that, Alan, I'd like to open up the call for questions, please.

Operator, Operator

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

George Staphos, Analyst

My first question is about costs. You mentioned the $0.31 year-on-year negative variance in operating costs, with converting costs being a little lower by $0.07. This results in a net negative of $0.24. In the first quarter year-on-year, you still saw positives, and netting those two from last quarter was $0.15. This indicates almost a $0.40 swing in just one quarter in terms of comparisons. Can you explain what the biggest factor in costs has been that you've been managing, and what the outlook is? You indicated higher operating costs into the third quarter. Can you provide more detail on what’s happening in the third quarter regarding these factors? I also have a couple of follow-up questions.

Bob Mundy, CFO

Yes, George, this is Bob. In the second quarter, we operated Wallula at full capacity, while last year it was only operational for one month. Wallula is our highest cost mill, so this had a significant impact on our cost mix. Additionally, energy costs and OCC were higher in the second quarter compared to the first. This should help close that gap. Moving from the second to the third quarter, we didn't provide much detail on cost guidance because we expect costs to remain fairly stable, with only slight increases in OCC and electrical usage rates. There may be a small uptick in chemical costs, but not as much sequential change as we've observed previously.

George Staphos, Analyst

Just holding at a very, very high level.

Mark Kowlzan, CEO

Yes.

Bob Mundy, CFO

Yes. Yes. Exactly.

George Staphos, Analyst

Understood. Secondly, can you discuss bookings and billings as you typically do early in the quarter? Additionally, what was the exit rate or momentum coming out of the second quarter?

Tom Hassfurther, Executive Vice President

George, this is Tom. Yes, bookings remain very robust. Bookings and billings both remain very robust. Through 12 days, we're up 12.5% so far in July. So an incredibly good start to the quarter. We had a very good start to last quarter. We exited at a higher rate and we're continuing that higher rate as you see going into the third quarter.

George Staphos, Analyst

Okay. My last one and I'll turn it over and related to sort of the volume outlook. Can you talk at all as to how your mix of business may have changed, if at all, now versus a year or 2 years ago? And frankly, the question that is behind the question, PKG's always seemingly done better than the industry over the years but the gap is quite stark when you look at it relative to still the macro data that's out there. So what do you attribute what's been very, very strong growth for PKG relative to a very mixed outlook where we look around the rest of consumer packaging? And how is mix changing? And can you talk a little bit about external sales which look like they're up? Is that a factor here in terms of what's happening with your revenue base?

Tom Hassfurther, Executive Vice President

Thanks, George. I’ll share what I can. The growth we’re experiencing primarily comes from our existing accounts and some new business, mainly in the brown area. In the marketplace, specialized areas like graphics have remained stable, while most of our growth has been in brown. From a mix perspective, it’s a slight change, not a drastic one. Our success stems from a dedicated team that is performing at a high level, staying focused on the customer, and aligning with the markets and customers we choose to do business with.

Operator, Operator

Our next question comes from Mike Roxland of Truist.

Mike Roxland, Analyst

Congrats on another good quarter. Just wanted to get a sense of your 2Q guidance during 1Q, you mentioned your guidance to $2.07, you rounded up at $2.20. Wondering what occurred during the quarter relative to your expectations that drove the beat?

Mark Kowlzan, CEO

Well, again, Mike, volume was the big factor. Obviously, operational efficiencies but the big volume boost was the positive there.

Mike Roxland, Analyst

I understand. So it was really a combination of volume and the cost efficiencies that you are continuing to pursue, especially since you mentioned the markets offering thousands of opportunities. These two factors really contributed to the $0.13 fee compared to your initial expectations?

Mark Kowlzan, CEO

Yes. Exactly.

Mike Roxland, Analyst

I would like to hear your thoughts on the evolving competition, as many seem to be adopting the strategy you've been following for a while, focusing on smaller local talents and prioritizing value over volume. Do you have any concerns about competitors pursuing a similar approach? How do you perceive this situation and what measures are you taking in case they become more aggressive in your market?

Mark Kowlzan, CEO

Yes. Personally, I don't have any concerns about that. People have talked about that for a number of years. But again, Tom, why don't you weigh in on that also?

Tom Hassfurther, Executive Vice President

Well, Mike, I would just say, listen, I mean, we don't really comment on our competition or what our competition is doing. We have our strategy, we go execute our strategy in the marketplace. And that is, as I've mentioned before, aligning with the right customers in the right segments. That's what we try to do. And what our competition is working on or is doing at the moment is really their plan, their program. And so I've got very little to comment on that.

Operator, Operator

The next question comes from Mark Weintraub of Seaport Research Partners.

Mark Weintraub, Analyst

So you mentioned Wallula negative mill mix impact. You're also though ramping up Jackson and or have ramped it up. And can you kind of give us a sense as to how much of a positive impact that has perhaps already had? And is there more that's likely to show up? And when would you expect it to be really operating at its highest levels of productivity, efficiency, cost position?

Mark Kowlzan, CEO

Jackson is delivering exactly what we needed to do. When we talked about this project 2 years ago, we said it was a 2,000 ton a day project, quite frankly, we've exceeded that. We've proven that the machine can run up with 2,400 tons a day which would be an 800,000 ton a year run rate. Currently, for the last couple of months, we've been running in the 1,900 ton a day up to 2,000 tons a day area which is again what CAR promised but it's all about running to demand. We make a lot of our specialty grades on that particular machine. And that machine is doing everything we need it to do right now. And the good news is that it will help us and be available to grow into the marketplace over the next year or 2 as we need the additional tons off that machine. But it's performing quite well and it's delivering everything that we needed to deliver on an earnings basis and a performance basis.

Mark Weintraub, Analyst

Can you remind us about the EBITDA contribution from Jackson? Is there an updated perspective or potential EBITDA contribution now that you see the production scope might be higher than initially expected?

Mark Kowlzan, CEO

Again, I think, Mark, it's delivering what we've talked about for the last 1.5 years to 2 years in terms of the model. But as I said, there's upside opportunity with the incremental tons that will feed into the converting system over the future. There's about a 400 ton a day opportunity as we go forward which is say 100-plus-thousand tons a year over the next couple of years as we feed that through. So that will be upside in EBITDA. But right now, it's delivering what our models told us it would deliver. And I think what some of you analysts have been modeling.

Mark Weintraub, Analyst

Got you. Regarding the increased capital expenditure, could you provide more details about the types of returns you might anticipate from this additional spending?

Mark Kowlzan, CEO

We don't get into the exact returns. Obviously, we have a history of high-return projects as a need project that Tom mentioned down in Arizona. We've been looking at an opportunity and a solution for a couple of years to move out of some older inefficient operating facilities. And so that's come about. We've also been aggressively pursuing some converting installations in new corrugators. And so all I'll say is these are very high return, great opportunities in line with our historical capital spend.

Mark Weintraub, Analyst

Okay. And then it sounds like a mix of cost and increased capacity. Is that fair?

Mark Kowlzan, CEO

Yes. I want to highlight that if you look back 10 years, you could build a full line plant for around $80 million to $90 million. However, the cost to construct a modern full line plant has now significantly increased, and in some cases, it is nearly double what it was a decade ago. This puts into perspective the expenses associated with operating in the current environment.

Mark Weintraub, Analyst

Is the size of the plant similar? Is it still around an $80,000 type throughput, or what throughputs are you referring to with this new plant?

Mark Kowlzan, CEO

This plant down in Arizona when we're done with it will be a couple of billion square feet a year opportunity for us.

Mark Weintraub, Analyst

Okay. Great. And then lastly. So, obviously, we got pricing in February and PPW, got it in June. Undoubtedly, that's helping the third quarter. Is there much that you would expect of the increases that have already been reflected in PPW to show up in 4Q and beyond? Maybe could you help us start to quantify how to frame it?

Tom Hassfurther, Executive Vice President

Mark, this is Tom. I want to mention that our current increase will take effect as it typically does for PCA over a 90-day period. We will start to see most of the results toward the end of the third quarter, with full realization in the fourth quarter. One confusing aspect, as I mentioned earlier, is that a lot of the first $40 increase was offset by the $20 announced late last year, which didn’t activate in many contracts, impacting our performance in the first half of the year. However, this $40 will roll through as expected in the standard 90-day period, while the non-contractual elements will be reflected in a 30- to 45-day time frame.

Operator, Operator

Our next question comes from Anthony Pettinari of Citi.

Anthony Pettinari, Analyst

I want to follow up on Mark's question. Regarding the additional $200 million in CapEx, is the majority of that allocated to the Arizona project? That's my first question.

Mark Kowlzan, CEO

No, that's part of it. As the year has gone on, we have continued to find ongoing opportunities at our existing plants, including new corrugators and new converting lines. We have actively pursued many of these opportunities. We also identified some immediate high return opportunities in the mills where we've allocated some of that extra capital. It's a varied approach overall, which provides a good opportunity and reduces the risk associated with any single large project.

Anthony Pettinari, Analyst

Got it. Got it. And in terms of sort of timeline for completion for Arizona and then obviously, you're not giving CapEx guidance for '25 but should we think directionally about CapEx maybe maintaining at these levels going forward, stepping down maybe in '25. Are we kind of in a CapEx cycle? Or just any kind of color you could give there would be helpful.

Mark Kowlzan, CEO

Yes. As far as the level of spending as long as we have opportunities, we're going to spend to the opportunities and we'll call that out as we have to, we'll give you an update in October for what the year is starting to finish up at. And then in January, we'll clue you into 2025. But I think, again, we've got a history of delivering results and again, I think for the time being, we're in this level of spending. But again, it's immediate high return. It feeds into this tremendous growth that we're seeing. And so we get immediate return for it. As far as the project down in Arizona, I think, Tom, we're kind of looking at late next spring type early part of next year of getting that plant started up.

Tom Hassfurther, Executive Vice President

Early, probably late first quarter, early second quarter. Yes.

Anthony Pettinari, Analyst

Got it. And for my last question, when you examine your end markets and the strong volumes across consumer, industrials, durables, and logistics, are there specific markets or customer segments that are really contributing to that strength? Or has there been an element of surprising demand strength?

Tom Hassfurther, Executive Vice President

I don't believe there were any major surprises for us, except that the consumer side has performed much better than many had anticipated. Consumers seem to be managing a bit better, although they might be relying more on credit cards and dipping into their savings. Overall, consumers remain quite healthy. However, the durable goods sector appears weaker, largely due to a decline in housing starts and challenges related to remodeling and supply issues. In general, while we see some minor adjustments in our mix, the specialty graphics area has remained relatively stable and is comparable to last year.

Operator, Operator

The next question comes from Gabe Hajde of Wells Fargo.

Gabe Hajde, Analyst

Hopefully, a couple of quick ones. One is kind of based on run rate production or I'm going to call it, directionally 5 million tons of capacity. You mentioned, I think you're at all 43,000 tons, I think, of year-over-year increased sales to outside or non-integrated tons. Are you at about 90% integrated at this point? And then on that, call it, 500,000 tons that you're not, to the extent that you do integrate it, should we be thinking about maybe $200 a ton of incremental profit that you realize when you internalize that? And yes, that's the question.

Mark Kowlzan, CEO

I think again, the number we're using internally is about a 95% integration. And as far as the value to us, I think you're in the ballpark. Bob, you got any comments?

Bob Mundy, CFO

I think it's possibly a bit more than that, Gabe, but yes.

Gabe Hajde, Analyst

Okay. And then we've got some new legislation regulation in the EU and I appreciate you're not in Europe. But just to the extent that it impacts kind of maybe global trade flows or implied values of virgin assets here in the U.S., do you see that putting maybe incremental upward tension on OCC over time as people look to use more in their furnish, or does that not even come into your thought process because you're focused on the U.S.?

Mark Kowlzan, CEO

I'm very familiar with what you're talking about. We've been paying attention to that at AF&PA for the last year. Again, I think that's the Europeans now realizing some of the unintended consequences of trying to do the right thing. And I think now that the election cycles have been completed in Europe, I think the reality is they're going to have to revisit that whole legislation and understand what the impact is. At the end of the day, they're going to need to pass to have fiber; and so they will resolve that matter. And so I'm personally from PCA's perspective, I'm not real concerned about it right now.

Gabe Hajde, Analyst

Okay. And last one, just on capital. Even with the increased spending, our model kind of has you guys still at 1x levered. You've always obviously taken a balanced approach with the dividend and share repurchase being a little bit more opportunistic. Anything changed either on the M&A front or a different perspective on capital as you look out over the next, I don't know, 12 months to return cash or value to shareholders?

Mark Kowlzan, CEO

Everything remains the same. We look at all opportunities, whether it's acquisitions, capital spending opportunities, dividend, share buyback, whatever makes sense at any given time, we're in a great position to be able to take advantage about anything that comes along. So nothing's changed. But we also, again, on the capital side, we have the organization that can quickly execute and take advantage of the ideas that currently come about and the needs that we have to work with our customers.

Operator, Operator

The next question comes from Phil Ng of Jefferies.

Philip Ng, Analyst

Congratulations on another strong quarter. I noticed that your views on demand for your major markets suggest that consumer demand is stable, while durable goods are still somewhat weak. This observation doesn't quite align with the increase in box volumes you've experienced over the past two to three quarters. So, are you seeing customers begin to restock? Are these customers you are closely aligned with, or is it that your growth is simply outpacing others, or have the investments you've made enabled you to capture market share more effectively? It appears that this situation is somewhat inconsistent with the current macroeconomic data we are observing.

Tom Hassfurther, Executive Vice President

Phil, this is Tom. I want to reiterate that we have a specific go-to-market strategy, which is focused on aligning with the right customers. By that, I mean we look for customers that are poised for growth in the future. We collaborate closely with these customers to ensure mutual success over the long term, and this approach has proven very advantageous for us. We tend to avoid customers that are more seasonal or have fluctuating demand. This long-term strategy has been consistently effective, and we are executing it well. There's been a lot of talk about our capital expenditures, and PCA has always maintained a steady capital spending strategy when opportunities arise. Our financial flexibility enables us to capitalize on these opportunities as they come up in the marketplace. This accurately represents what we observe in the market. While some of our growth may diverge from macro trends, a deeper look into specific industries or segments will reveal that many are experiencing significantly higher growth than others.

Philip Ng, Analyst

Are you seeing any restocking from your customers at this point?

Tom Hassfurther, Executive Vice President

Our customers are generally maintaining a very conservative level of inventory. We completed the destocking phase some time ago. They have replenished some inventory, but overall, it remains on the historically lower side.

Operator, Operator

The next question comes from Charlie Muir-Sands of BNP Paribas.

Charlie Muir-Sands, Analyst

I have two questions. First, regarding the new Arizona box plant, you mentioned its capacity would be 2 billion square feet annually. Can you clarify the upgrade this represents or the capacity of the existing site you are closing? Second, about the competitive landscape, I understand you prefer not to discuss individual competitors, but there appears to be a general trend of increasing prices. Are you considering following this trend, or are you more focused on gaining market share and enhancing operating efficiency?

Mark Kowlzan, CEO

On your second part there, we're not going to talk about price. But on your first part of your question, we're going to more than double the capacity down in Arizona. Tom, do you want to give a few more details on that?

Tom Hassfurther, Executive Vice President

There isn't much to discuss aside from the fact that we are clearly beyond our capacity in that marketplace. We are unable to serve local customers as we would like, which forces us to source from various plants that are often quite distant, such as those in the L.A. region. This approach is not sustainable in the long run. The customers we have in that market have expressed the need for us to implement significant changes, and we will address that. This will present us with some excellent opportunities in that region.

Mark Kowlzan, CEO

And if you look back at our portfolio of opportunities over the last 6 years, in general, we've taken a lot of these older plants that needed to be recapitalized. And we've increased productivity on a unit labor hour basis. We tripled quadrupled the productivity coming out of these plants and cut costs and done it with a lot less labor hours. So it's again, the plant in Arizona will be a really big opportunity for us to take care of that whole region.

Operator, Operator

Mr. Kowlzan, I see there are no more questions. Do you have any closing comments?

Mark Kowlzan, CEO

Alan, thank you. And again, everybody that participated. I want to thank you for joining us today and look forward to talking with you in October to review the third quarter call. Have a nice day. Bye, bye.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.