Sylvamo Corp Q3 FY2023 Earnings Call

Thanks, Greg. Good morning, and thank you for joining our call today. Our speakers this morning are Jean-Michel Ribiéras, Chairman and Chief Executive Officer; and John Sims, Senior Vice President and Chief Financial Officer. Slides 2 and 3 contain important information, 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. Reconciliations of those figures to U.S. GAAP financial measures are available in the appendix. Our website also contains copies of the third quarter 2023 earnings press release as well as today's presentation. With that, I'll turn the call over to Jean-Michel.

Thanks, Hans. Good morning, and thank you for joining our call. Let's turn to Slide 4, please. In the third quarter, we achieved $158 million in adjusted EBITDA and generated strong free cash flow of $155 million. We achieved adjusted operating earnings of $1.70 per share. Price and mix, operation, and input transportation costs were all favorable to the outlook we provided in our second quarter call. Our third quarter volume was short of our expectations, reflecting ongoing China inventory destocking and weaker-than-expected demand. We strengthened our financial position in the third quarter with net debt of $796 million, another 1.2x net debt to adjusted EBITDA ratio. We also deposited $60 million in escrow to remove cash return needs related to the Brazil tax dispute in our credit agreement while returning $24 million in cash to shareholders in the quarter. Slide 5 compares our third quarter key financial metrics versus prior periods. In the third quarter, our earnings were better than our outlook, and we took measures to maximize free cash flow, including selling and administrative cost reduction, shrinking working capital, and adjusting the timing of capital spending. I'm proud of our teams collaborated to take care of our customer needs while executing significant economic downtime safely and as efficiently as possible. Now John will discuss our third quarter performance in more detail. John?

Thank you, Jean-Michel. Good morning, everyone, and thanks for joining our call. Slide 6 shows our third quarter earnings bridge. As Jean-Michel stated, we earned $158 million of adjusted EBITDA in the quarter, which was slightly higher than our guidance of $130 million to $150 million. Let's discuss the changes versus the second quarter adjusted EBITDA. Price and mix decreased by $55 million, due primarily to lower paper prices in Europe and Latin America export markets, as well as lower global pulp sales. Volume increased by $6 million in the Americas, while Europe remained stable. Operations and other costs improved by $1 million with better operating and supply chain results offset by $13 million in higher unabsorbed fixed costs due to increased economic downtime. Planned maintenance outage costs decreased by $55 million with no major planned outages in the quarter. Input and transportation costs improved by $27 million, driven by favorable fiber, chemical, and transportation costs. So let's move to Slide 7. This slide assumes world graphic paper demand at just over 100 million tons. Here, you can see that uncoated freesheet is the largest and most resilient of all the graphic paper grades. What separates uncoated freesheet? It's quite simple. Uncoated freesheet has the highest number of end-use applications and is used across all sectors of the economy. Uncoated freesheet is sustainable, affordable, and functional. And we believe paper will remain an effective vehicle for education, communication, and entertainment for a long time. Paper plays a critical role in education. Studies continue to show that students of all ages absorb more when reading on paper versus reading on digital screens. In fact, Sweden recently moved students off digital devices and back to books and handwriting on paper. This is why total demand for uncoated freesheet exceeds the sum of all the other printing and writing grades combined. Let's turn to Slide 8. We continue to believe that current uncoated freesheet consumption is better than the demand data suggests. The Pulp and Paper Products Council has published data that shows year-over-year changes in estimated consumption versus demand. And on this slide, you can see North American comparisons for 2021, '22, and the first half of '23. The Pulp and Paper Products Council shares our view that coming out of the pandemic, customers were buying more paper than they were using. And this year, they're using more paper than they are buying. The situations in Europe and Latin America are similar. Moving to Slide 9. Current industry conditions are starting to show signs of improvement. U.S. advertising is starting to pick back up, and the U.S. economy continues to show vitality. And uncoated freesheet, with channel destocking nearly completed, we are starting to see increased order entry globally. Pulp inventory levels have improved significantly globally, and prices are increasing globally. Slide 10, please. We expect to deliver fourth-quarter adjusted EBITDA of $90 million to $110 million. We project price and mix to decrease at a slower rate of $20 million to $25 million, primarily reflecting prior paper price decreases in Europe and unfavorable geographic mix in the Americas. We expect volume to improve by $20 million to $25 million. This reflects seasonally stronger volume in Latin America, the completion of destocking in Europe and North America, as well as a new business we picked up in North America. Operations and other costs are projected to increase by $25 million to $30 million, and this is primarily due to higher seasonal operating costs in Europe and North America. We expect input and transportation costs to increase by $5 million to $10 million due to seasonally higher energy. Planned maintenance outages are projected to increase by $25 million as we have outages in all our regions in this quarter. We project adjusted operating earnings of $0.55 to $0.90 per share. This level of fourth quarter adjusted EBITDA may be a bit less than expected, and here's how I think about it. At current industry demand, price, and input costs, the quarter would be $15 million to $25 million higher, adjusting for three factors. First, normalizing for planned maintenance outages. Second, adjusting for higher cold weather operating costs, and third, we're taking some more downtime to reduce our inventories in the fourth quarter, especially in North America. Let's go to Slide 11. We compete as a low-cost producer of commodity products sold to a mature demand cyclical market. To become a leaner, stronger company, we initiated Project Horizon to streamline our organization and improve our cost structure. Before inflation, we are targeting a run rate savings of $110 million by the end of 2024. About two-thirds of the target will come from operational cost reductions in our mills and supply chains by improving efficiencies, accelerating our cost reduction capital spending pipeline, and reducing direct variable and indirect costs. The remainder will come from selling and administrative cost reductions, including the elimination of about 150 salaried positions globally, or nearly 7% of our salaried workforce. Let's move to Slide 12 to talk about how we are allocating cash to create value. Year-to-date, through the third quarter, we have generated $190 million in free cash flow. We will continue to maintain a strong balance sheet, return substantial cash to shareholders, and create value by reinvesting in our business. During the third quarter, year-to-date, we repaid $36 million of debt, and in October, we repaid another $10 million. As of November 9, we have returned $110 million in cash to shareholders and plan to return $125 million this year. Remember, we also deposited $60 million in escrow in the third quarter so we can return more than $90 million. Our board of directors increased our regular dividend by 20% and declared a $0.30 per share special dividend. We paid both totaling $25 million on October 17. The Board also authorized an incremental $150 million share repurchase program. At the end of the third quarter, the May 2022 and the September 2023 authorizations collectively had $167 million remaining. We will continue to look for opportunities to repurchase shares at attractive prices. Jean-Michel, I'll turn it back to you.

Thanks, John. I'm now on Slide 13. In October, we celebrated our two-year anniversary. Who would have thought that we would go through such extreme industry cycles in the first two years? Being a low-cost global producer with strong supply position and iconic brands has positioned us well. We have created significant shareholder value by managing what we can control. First, we have allocated cash to improve our financial position by reducing debt by 35% from $530 million to strengthen our balance sheet. Second, we continue to deliver on our investment thesis. We have earned over $1.3 billion in adjusted EBITDA, which is a 19% margin. We also generated $568 million in free cash flow and returned $200 million to shareholders since our spinoff. Third, we continue to reinvest in our business to strengthen our low-cost assets. We have invested $318 million and are accelerating investment in high-return capital projects. I'll conclude my remarks on Slide 14. We are strengthening our ability to create shareholder value throughout the cycle. Sylvamo remains a cash flow story, and we are now projecting more than $270 million in free cash flow this year. We are building on our strong supply position while we further develop our strategic channel partnerships. Operational excellence remains key to our performance as we leverage our low-cost assets and Brazilian forestlands. John walked you through our cost reduction initiative, Project Horizon, which will make us a leaner, stronger company. We understand our efforts to reduce our global strategic position may affect our colleagues whose positions would be eliminated. We will help these employees by providing transition service and want to thank them for their service. Financial discipline is very important to us. We will continue to leverage our strength to drive high returns on invested capital, generate free cash flow, and use that cash to increase shareholders' value by maintaining a strong financial position, returning cash to shareholders, and reinvesting in our business. We will create long-term value through a talented team, iconic brands, and low-cost mills in favorable locations. We're confident in our future and motivated by the opportunities that lie ahead. With that, I'll turn the call back to Hans.

Thanks, Jean-Michel, and thank you, John. Okay, Greg, we're ready to take questions.

Thanks very much. Hi everyone. Good morning. Thanks for the details. The first question I wanted to hit on is with Project Horizon. The deck speaks to about $22 million of run rate savings from the salaried reduction, if I'm reading it correctly, the footnote correctly. In total, what net benefit do you think you'll be able to get from the program in '24, recognizing, obviously, it affects a number of people who worked with the organization for a long time, and it's bittersweet, but what do you think the net benefit to the P&L would be from this program in '24?

George, it's John. To answer your question, we're talking $110 million run rate by the end of 2024, and we do have on the slide, we're estimating that inflation for 2024 can be approximately $50 million. So the net benefit in total will be $60 million once we get to the full run rate. In 2024, we're expecting a net benefit of about $10 million to $15 million.

The second question relates to the volumes we’ve been observing, which seem larger and worse than anticipated from an amplitude standpoint. Historically, this isn't unreasonable and remains fairly consistent. We've noticed significant drops in demand during major economic downturns or slowdowns. Regardless of whether we're officially in a recession, the companies I've analyzed over the past year show that packaging paper volumes have essentially been experiencing a recession. Typically, this situation doesn’t lead to a genuine rebound in demand; instead, productivity increases, resulting in a new baseline demand for uncoated freesheet. What are your thoughts on our current position regarding potential further demand destruction? Ideally, this issue would be resolved. Additionally, if you were to estimate now, what do you project for your shipments and demand in 2024 compared to the previous year?

It's Jean-Michel. Thanks for joining the call. I think, as you said, we've added in our cycle some more strong numbers sometimes decrease due to economic factors, due to COVID, due to multiple factors. Even if you take '23 strong decrease, we are still in our trend back to 4% to 6% in the U.S. downturn and back to 3% to 4% down in Europe. I think we are on this trend, and we're going to continue to be on this trend. What happens is when you have strong elements like inventory correction you've seen this year, you could kind of think it is much worse than this trend and numbers show it's not. '24, it's difficult to predict. What we do know in '24 is we do not expect to have the inventory correction again. So when you compare it to '23, it should probably look better, but on the trend, demand deep, I think there is no change. It's still a minus 5% globally.

Sorry, go ahead, John.

I would like to add one more point: we agree with your observation. For North America, Europe, and Latin America, demand is down, but this is largely due to inventory corrections. It is important to note that for one segment of our market, we are not experiencing the recessionary decline you mentioned.

Should we anticipate that demand will align with consumption on a year-over-year basis in 2024? Or do you foresee some inventory replenishment that could lead to year-over-year percentage increases for the grades? Lastly, could you elaborate on the new win in North America that you mentioned? That would be appreciated. I'll return to the queue.

Yes. So we do expect to be at least at the level of consumption. I would say maybe some inventory correction would be an upside, but our expectation is to be more at normal demand consumption right now. As you mentioned, the upside. If you remember, in North America, we mentioned, I think it was last quarter, the one before. With the closing of the Canton mill, there was an opportunity to take some new businesses for us in North America, and we did. So that's what we mean by that.

Thank you. I’ll turn it over.

Good morning. Thank you for taking my questions. I’d like to follow up on Project Horizon. Can you provide more details on the opportunities you see for reducing costs in the manufacturing supply chain? Specifically, are there any mills or regions that stand out as having the best potential for savings? Also, will capital investment be necessary to realize these savings?

Yes, Matt. Firstly, some of this involves realizing the capital we've already invested in cost reduction. Additionally, we have planned cost reduction investments for next year that are expected to provide some benefits. We're also continuing to focus on improving efficiencies in energy usage, chemical consumption, and overall operations.

I'll add to that. We have some form of a little bit of opportunities in supply chain, especially in North America. When we spun, we kept the network we had before mostly intact. We did not look at what was the opportunities to ameliorate, optimize that network. I know that we have two years of experience and understand better the market, and we think we have opportunities to significantly improve our supply chain operation efficiency, especially in North America. That's probably where we have the biggest supply chain. We now have good opportunities there too.

That's helpful, thank you. It seems like you're anticipating that the channel inventory correction will mostly be finished by the end of the year. Is this expectation consistent across different regions, or are there specific areas that might differ? I'm particularly interested in Latin America, as I recall you've mentioned that it has shown varying demand trends and is expected to be stronger in the fourth quarter.

Yes. I think Latin America, the strongest we saw was not Brazil, but other Latin America. And I will say with the other pattern we have right now, we can say this is behind us. I would say both Europe and North America, especially in the last four weeks when we see our order intake and what our customers said that give us a good indication that the inventory correction is done.

Okay, thanks. That's all for me. I'll turn it back.

Thanks so much. So I want to come back, I think Matthew queued it up nicely on Project Horizon. So was this a program that you developed internally either from existing learnings you had within Sylvamo or the predecessor company? Or did you bring in somebody from outside the firm to sort of teach you whatever you're doing to get at these net savings over time? And then again, we've got supply chain, we've had efficiencies, that's all well and good, and we wish you well in the program. But is there something sort of unique to this program relative to past cost reduction programs that you might have been associated with either at Sylvamo or prior companies that we should keep in mind and give us more or less optimism on its prospects?

Two things on that, George. First of all, we named it Project Horizon because this is a project that talks about the future for Sylvamo. So we knew coming out of the spin that we could operate more efficiently, leaner, more focused, and the plan was to get there as soon as we got the spin behind us. And so we did this internally. This is about focusing on our strategy and making sure that we have the organizations and the capabilities we need to execute going forward. So this is from an internal perspective. We did not go to outside resources for that. And the same is true for our operational side. Some of this has to do with us continuing to ramp up our investments that we've been doing and showing in terms of our facilities, both in maintenance and the cost reduction capital. But it's also more of a concerted effort and focused on areas of opportunities we have to improve our operations. We set a short time frame because we want to be able to execute this quickly, and we wanted to be able to show that you ought to be able to see it on the bottom line pretty quickly. Now we talked about $10 million to $15 million in 2024, but this is going to be an exit rate. So you should be seeing it beginning first quarter of 2025.

If I may, George, I would just add, just in supply chain, when I was talking about network optimization, we did get some specialist supply chain services to help us, and we're continuing to have them helping us redesign our network and think about it differently.

Okay. But actually, I just want to make sure I understood. So the $10 million to $15 million, I took it as a net realized with the run rate being after inflation, the $60 million or so. Did I get that incorrectly? And if I got it correctly, does that mean then there's another $30 million to $40 million benefit that you get in '25 based on the program?

That's the way. The net benefits in the $15 million after inflation and the $60 million is net of inflation.

Okay. And on the Ops efficiencies, I mean is it just purely you went machine-by-machine, boiler by boiler and just did indexing and yield analysis? Or was there something else related to the program? I'm sure it's much more, but is that the fundamental that you were employing there?

Yes. That's probably a good way to describe it. It was a bottoms-up work with extensive feedback or information from everybody working in our facilities.

And some of it is also due to our cost investment that John mentioned. We've invested in some equipment, in some mills, much better online data analytics to get the capacity now to much better understand clients and predict them and act on them. So some of the cost programs we've done with this automation, I won't call it AI, it's too much, but I would call it digital progress in the mills. Analytics is helping us also a lot.

And George, let me clarify that these are structural changes. We are looking at $110 million, which represents sustainable changes. This amount does not factor in increased volume or the fixed costs we could not absorb this year due to the lack of order downtime caused by the inventory correction. So that is not included in this $110 million.

Interesting, John. One last quick for me and then I'll turn it back and try to get back in queue. I remember a discussion about Latin America seeing some improvement in volumes with the textbook program, did that materialize? And how is the order book in Latin America going into '24?

Yes, it did materialize mostly. And the order book is good. It's a seasonality also which is always very good in the fourth quarter. So the fourth quarter in Latin America is the strongest one, the first quarter the weakest one, but that's just a seasonal demand.

Thank you.

Your line is open. Please go ahead.

Oh. Thank you so much. Last one for me. So share repurchase currently available authorization did you say $160 million? And do you have an outlook on maintenance at this juncture for '24?

Yes, we have an authorization of $167 million. We are still working on a plan for 2024, and we will likely share the maintenance outlook when we announce the fourth quarter results.

Okay. At this juncture, would you expect relatively flat? Or could it be lower or likely higher?

I would say right now, relatively flat.

Thank you, John. Yes. Understood. Thank you, guys.

Thanks, Greg. Before I wrap up the call, Jean-Michel, any closing comments?

First of all, thank you for joining our call. We remain a cash flow story. We're projecting $270 million in free cash flow this year and remain committed to returning $125 million to shareholders. We remain confident in our ability to generate strong EBITDA and free cash flows throughout the cycle. We will exit this current industry down cycle as a leaner, stronger company. We allocate capital to increase shareholder value. We use cash to maintain a strong balance sheet, return cash to shareholders, and reinvest to strengthen our businesses. We are confident in the future. So thank you, everybody.

Thanks for joining our call today. We appreciate your interest in Sylvamo, and we look forward to the discussions in the coming weeks and months ahead. Thank you so much.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Teleconference. You may now disconnect.