Sonoco Products Co Q3 FY2023 Earnings Call

Thank you, operator, and thanks to everyone for joining us today for Sonoco's Third Quarter 2023 Earnings Call. Joining me this morning are Howard Coker, President and CEO; Rob Dillard, Chief Financial Officer; and Rodger Fuller, Chief Operating Officer. Last evening, we issued a news release highlighting our financial performance for the third quarter, and we prepared a presentation that we will reference during this call. The press release and presentation are available online under the Investor Relations section of our website at sonoco.com. As a reminder, during today's call, we will discuss a number of forward-looking statements based on current expectations, estimates and projections. These statements are not guarantees of future performance and are subject to certain risks and uncertainties. Therefore, actual results may differ materially. Please take a moment to review the forward-looking statements on Page 2 of the presentation. Additionally, today's presentation includes the use of non-GAAP financial measures which management believes provides useful information to investors about the company's financial condition and results of operations. Further information about the company's use of non-GAAP financial measures, including definitions as well as reconciliations to GAAP measures is available under the Investor Relations section of our website. For today's call, we will have prepared remarks regarding our results for the quarter and outlook for the fourth quarter, followed by a Q&A session. If you will turn to Slide 4 in our presentation, I will now turn the call over to our CEO, Howard Coker.

Okay. Well, thank you, Lisa. Good morning, everyone, and thank you for joining our third quarter 2023 earnings call. Let me begin with highlights of the quarter. For Sonoco, we executed well, even with the ongoing market uncertainty. Sales came in at $1.71 billion, adjusted EBITDA was $280 million and adjusted earnings per share was $1.46. Sales were flat sequentially and generally in line with expectations. In the industrial sector, demand remains muted and volumes low. In consumer, volumes were sequentially higher in most businesses, while metal aerosol can volumes continue to underperform driven by lower end market demand and ongoing customer destocking. Our profit results were better than expected from strong productivity and effective cost management by our teams. Our productivity results are benefiting from the capital investments we are making across our plant network including automation, process improvements and energy cost reductions. We expanded adjusted EBITDA margins to over 16% and delivered strong cash flow during the quarter. We achieved these results even while we continue to invest in long-term value-adding projects and R&D initiatives throughout the portfolio. Overall, I'm pleased with how these results reflect our continued ability to execute simplification, transformation and operational excellence initiatives to build a more resilient company with strong performance through the cycles. We were also pleased to close the RTS Packaging and Chattanooga Paper mill acquisition in September. These acquisitions are well aligned with Sonoco's long-term strategy to focus on our core integrated businesses and expand our sustainable consumer packaging portfolio, serving food, beverage and beauty markets. The integration process is well underway, and we are delighted to welcome our new colleagues to Sonoco. And with that, I will turn it over to Rob for more details on the quarter.

Thanks, Howard. I'll begin on Slide 6 with a review of key financial results for the third quarter. Please note that all results are on an adjusted basis and all growth metrics are on a year-over-year basis, unless otherwise stated. The GAAP to non-GAAP EPS reconciliation is in the appendix of this presentation and in the press release. As Howard said, third quarter financial results reflect Sonoco's continued ability to deliver strong results in a low volume environment. We generated sequential growth in sales and adjusted EBITDA and improved the adjusted EBITDA margin to 16.4%. Furthermore, we exceeded our expectations and achieved adjusted EPS of $1.46. This strong profitability was broad-based as impactful cost controls and improved productivity drove near-record profitability in both flexibles and rigid paper containers in the Consumer segment and strong profitability in the Industrial segment. In the third quarter, consolidated sales decreased to $1.7 billion. Sales decreased due to low volumes and index-based price decreases in both Consumer and Industrial. Adjusted operating profit decreased to $213 million and adjusted EBITDA decreased to $280 million. We maintained an above 16% adjusted EBITDA margin due to improved productivity and long-term cost controls associated with our ongoing business transformation program. Adjusted EPS of $1.46 was driven by strong operating performance as well as favorable tax and FX. Adjusted EPS increased sequentially from the second quarter due to modest volume improvement, positive productivity and positive nonoperating factors despite negative price/cost. The sales bridge on Slide 7 explains the year-over-year change in sales in the quarter. Volume/mix was negative $145 million or negative 7.7%. This volume decrease was anticipated and was the product of weakening consumer demand due to the impact of inflationary pricing and destocking at retail and continued low industrial demand. We continue to take steps to improve demand visibility, and we are managing the business to mitigate the impact of low volumes. Price was negative $58 million. Our pricing performance was driven by index-based price decreases, primarily in resin and metals-based businesses. FX and other had a positive impact of $23 million with FX contributing $17 million. The adjusted operating profit bridge explains the year-over-year change in adjusted operating profit in the quarter. Volume/mix was negative $31 million as low volumes impacted profitability. Price/cost was negative $10 million as index-based prices declined more than overall inputs declined on a year-over-year basis. We continue to experience inflation in fixed costs and variable inputs like labor, while market-oriented inputs that drive index-based pricing such as metal and most resins declined on a year-over-year basis. Productivity was $30 million due to restructuring activities targeting fixed cost and favorable manufacturing and purchasing performance. Slide 8 has an overview of our segment performance for the quarter. Consumer sales decreased to $938 million. Consumer volumes decreased 8.1% due to inflationary pricing and continued destocking at retail. Customers of our Consumer Packaging remain cautious. We believe that our solutions are winning share. Rigid Paper Container Sales were flat as continued global growth, especially in Europe and Latin America, was offset by weakness in North America. Flexible sales decreased high single digits as low volume with legacy customers offset share gains with new customers. Metal Packaging sales decreased due to template-based pricing decreases and lower volume in both food and aerosol. Demand from our core customers has stabilized and indications are that destocking with these customers has moderated. Consumer operating profit decreased to $112 million as strong productivity was offset by lower volume/mix and negative price/cost. Consumer operating profit margin increased to 11.9%. Flexibles and rigid paper containers both had near record operating profit due to strong productivity. Turning to Industrial. Industrial sales decreased to $580 million. Industrial volumes decreased 7.5% due to lower demand in all key markets and geographies. We believe these declines are not share related as indications are that we continue to gain share based on quality and service. Operating profit decreased to $75 million due to lower volumes and negative price/cost. We generated positive productivity due to our focus on improving paper mill utilization and reducing fixed cost and SG&A. Recent capital investments such as Project Horizon have enabled us to focus on the right markets with the right assets. We are operating with agility and continue to evaluate system improvements to maximize profitability. Operating profit margin remained at a historically strong 12.9% and meaningful improvement from previous economic lows. All other sales decreased to $192 million due to low volumes. Operating profit increased 66% to $26 million due to strong price cost and productivity. Moving to Slide 9. Our capital allocation framework aligns with our business strategy to drive value creation through earnings growth and higher margins. Our priority is to dynamically allocate capital to long-term strategies to improve growth and profitability in our core businesses. We remain focused on increasing the dividend, which at present is $0.51 per share on a quarterly basis or an approximate 4% annualized yield based on our current share price. After capital investments in the dividend, we prioritize investments in accretive and strategic M&A, balanced against our priority of maintaining strong liquidity and access to capital. In the third quarter, we increased the size of our revolving credit facility and refinanced our term loans to extend maturities and reduce average interest rates, while also funding the RTS acquisition. We began the fourth quarter with record liquidity and the ability to continue to pay down debt with cash from operations. In the third quarter, we generated operating cash flow of $268 million and invested $93 million in capital expenditures. On Slide 10, we have our guidance update. We are increasing our full year 2023 EPS guidance to $5.25 to $5.40, raising the lower end of the range to reflect our year-to-date performance, but maintaining the top end of the range to reflect the current market instability, especially considering recent weak demand trends in December. We're also increasing our full year 2023 adjusted EBITDA guidance to $1.05 billion to $1.08 billion. To reflect these changes and to reflect our expectation of maintaining higher receivables and lower payables than anticipated, we are revising our full year 2023 operating cash flow guidance to $850 million to $900 million. We are managing capital expenditures appropriately and expect to invest between $300 million and $325 million in 2023. Now Rodger will discuss the fourth quarter outlook.

Thanks, Rob. If you please turn to Slide 11 for our view on the segment performance drivers for the fourth quarter of 2023. First, in the Consumer segment for the fourth quarter, we expect stable volume performance versus last year and down slightly sequentially to the third quarter due to seasonality, primarily in our flexible and rigid plastics businesses. In our Global Rigid Paper Containers business, softness in some legacy products is being offset by new products using our proprietary sustainable paper solutions. We’re excited to continue the global expansion of our rigid paper containers as we utilize the new capacity added in our existing operations in Brazil, Malaysia and Poland. These operations are utilizing our state-of-the-art equipment and automation technologies with plans for more investments in 2024 in emerging markets for paper cans. In our Flexible Packaging business, we expect seasonally lower volumes after the third quarter holiday pack, but we should see continued solid productivity in flexibles as a result of recent investments in new technology. In metal cans, we expect seasonally lower food can volumes after the peak pack season in the third quarter, and metal aerosol volumes are expected to remain soft in the fourth quarter. We expect positive productivity in metal to continue in the fourth quarter due to capital investments. Turning to the Industrial segment. As we expected for the second half of 2023, global demand for our paper and converted products remains soft. In the fourth quarter, global industrial volumes will be slightly lower versus last year. We have seen some slight demand improvement in our North American paper and converted products business with Europe and Asia remaining quite weak. Also in the fourth quarter, price/cost benefits will be lower in industrial due to index-based pricing and cost inputs. With the lower volumes in Industrial, productivity improvements remain challenging, but we will continue to aggressively manage variable expenses as a countermeasure to minimize the impacts from volume deleveraging. And finally, in all other businesses, we expect slightly lower volumes from seasonality. So in conclusion for the fourth quarter, the team is focused on cost control, footprint optimization in all forms of productivity will be critical until we see a sustained improvement in customer demand. And with that, back to you, Howard.

All right. Thanks, Rodger. In closing, I just want to state that despite all the external demand uncertainty this year, our team is performing extremely well. And we have continued to solidify the foundation of Sonoco and make progress on our strategic initiatives. Speaking further on behalf of Sonoco's management team, I would like to recognize the dedication and hard work demonstrated through the quarter and year at this point, and thank all of you for the work you've done. While transformation is well underway, there is still more to be done, and I know our teams are up to the challenge. And just to further touch on these strategic initiatives, which I've been covering through the year, I'll remind you that we're only midway through reshaping our portfolio, and we look forward to completing our noncore divestitures when we can maximize value in the marketplace. On the operating model side, Sonoco is becoming a more focused, agile and operationally efficient company. The continued optimization of our mix and factory footprint, combined with driving productivity and value-added capital projects will sustain and drive margin expansion in the future. Our balance sheet remains strong, and we continue to generate cash and allocate capital in a disciplined and efficient management. And lastly, our commitment to ESG and sustainability initiatives are unwavering and remain wholly aligned to the core values of the company. There are a lot of great things going on in Sonoco and the team, and I generally look forward to providing more in-depth updates on our progress during our planned Sonoco Investor Day, which is scheduled for February 22 of next year at 75 Rockefeller Plaza in New York City. We will be sharing key updates on our segments, our markets and our fantastic technology innovations, and we look forward to seeing you there. At this time, operator, we would be happy to answer any questions that folks may have.

Our first question will be coming from George Staphos of Bank of America.

I have a question for Howard and the team regarding the third quarter. You performed better than your guidance, which is a great achievement. It seems like much of that improvement came from increased productivity. Could you clarify what drove this outperformance? As we look ahead to the fourth quarter, do you anticipate this trend continuing, even though there is a forecasted steeper decline in earnings year-on-year? Additionally, is this decline primarily due to the price/cost dynamic becoming more unfavorable as you mentioned? Any insights on that would be appreciated. I have a follow-up question after this.

Sure, George. Yes, the third quarter volumes were about where we expected them to be a little bit softer, but you're right, productivity actually covered that. So that's the real driver as well as how we manage general cost containment, et cetera. As we look into the fourth quarter, we're seeing seasonal-type declines ahead of us. I expect that productivity still should be pretty solid. The real question mark is all around what the volumes are going to be. And as we hit into that December time frame, that's the real watchout for us. So we see people taking extended downtime around the holidays, et cetera. So being cautious in that regard. But that's the main drivers of what we're looking at for the remainder of the year. Do you guys have any other?

Yes, George. That's a good question. I think that Howard hit it right. If you think about next quarter, what we're thinking as volume will be a little bit weaker just generally because of the seasonality, and we always have been cautious about projecting December in the last couple of years. But the productivity performance has been really strong, and it is due to some of the strategic investments we've been making. So we're hitting really on all 3 cylinders of our procurement, manufacturing and really getting after fixed cost. And that's what all the activity the team has been doing. So if you think about year-over-year in the fourth quarter, we're expecting to have pretty similar year-over-year performance and productivity of between $0.20 and $0.25 of improvement. And so we feel really good about how all that's starting to flow through the P&L.

I have a related question and then a quick one about metals. You mentioned that your legacy flexible segment was weak, but you've gained some new business that helped mitigate that. Rigid paper sales were down in North America, which seems to be a recurring theme among companies. What are your key consumer market customers saying about whether we are through the destocking phase and if consumer demand is improving as we approach 2024? Additionally, how is metal performing compared to your deal model at this point, considering the volume decline we've experienced?

Yes. Our customers are indicating that we're beginning to notice increased promotional activity and discounting. Throughout the year, we've been grappling with price inflation, and we're starting to see some relief from that. However, we don't anticipate any significant impact in the first quarter. It's still early to assess what the upcoming year will look like. I'm in discussions with customers, and the changes in pricing to drive volume are evident on the shelves. Regarding the deal model for metal, we're performing as we expected, particularly as we approach the end of year two, considering the ups and downs of year one. Last year was exceptional, especially when we compare the inventory variances year-over-year. Averaging these out puts us exactly where we anticipated. We're pleased with that. Even more importantly, the integration process has gone extremely well. The synergies we identified are materializing, and we've even discovered additional synergies that we didn't initially foresee. The market's response has been overwhelmingly positive. Remember, this is a marathon, not a sprint. We're very satisfied with the integration process and the overall financial performance, and we're looking forward to capitalizing on the synergies and opportunities that lie ahead.

Our next question will come from Anthony Pettinari of Citi.

Just following up on George's question. In Consumer, you obviously sell into a lot of different end markets and customers. I'm just wondering, are there specific markets where destocking maybe is a bit closer to an end or others where maybe you're seeing new rounds of destocking or pullback that's surprising you? And I'm sorry if I missed this, but is it possible to quantify what you're expecting for 4Q in Consumer on a year-over-year basis?

In the Consumer segment for the fourth quarter, we anticipate flat year-over-year results, with some improvements in the metals and can areas, both metal and paper, while facing ongoing volume challenges in flexible packaging, but overall remaining flat compared to last year. A closer inspection reveals variability on a SKU level. In the flexible segment, categories like confectionery and snacks have been notably weak, which appears to be more related to shelf pricing rather than destocking. The actual inventory reductions are more prominent in the metal portion of our business, where products typically have longer shelf lives. As Howard mentioned, we're beginning to see that situation improve, but not completely resolve. Therefore, we expect slightly better metal volumes in this fourth quarter compared to the same period last year.

Okay. That's very helpful. And then in Industrial, you talked about maybe some improvement in the U.S. I don't know if that's just purely a function of easier comps or there's maybe some organic growth there. And I'm just wondering if you can comment on that. And then in Asia and Europe, understanding you don't have great visibility and there's a lot of macro uncertainty, do you have any sense whether those markets are getting worse or sort of stable or getting better or any other comments you can give there?

Yes, Rodger, again. Yes, North America, I said slight improvements, and I think that's what we've seen. We've certainly seen we feel like the bottom in North America from a volume standpoint in industrials. If you look at our URB system, we operated at about 85% capacity in the third quarter, which was 5% better than the marketplace. So we felt good about that. That's coming from our integrated system as well as some really good, strong, long-term customer relationships. So North America, a little sign of improvement. I wouldn't call it a trend yet, but we'll see how it goes in the fourth quarter and move into the first quarter. Europe and Asia remain weak. It's not getting worse, which is nice, but they remain weak. The URB systems ran in that 75% to 80% capacity area, but we expect the same for the fourth quarter. And if you look at year-over-year Industrial volumes for the fourth quarter, we're calling it down about 1.5% to 2%, and that's versus down 7.5% in the third quarter year-over-year. So incrementally, we're seeing a little improvement, plus, of course, the comps are getting easier as we move quarter-to-quarter, and that will continue into the first half of next year.

Yes. I want to add that regarding our volume situation, we feel we've been experiencing a downturn in manufacturing since last December. Our volumes, especially in the Industrial sector, have faced significant challenges during this time. However, I must express my admiration for our team's performance. We've discussed productivity and the investments we've made. While it's good that we aren't constantly focusing on Project Horizon, it exemplifies our current position in the corrugated medium market. This situation will help stabilize and ultimately enhance our overall Industrial margins, especially in challenging times. Although we're seeing some declines from last year's high price/cost levels despite tough volumes, we are very confident in maintaining double-digit margins even now. What excites me about our current standing is that a recovery is ahead. We aren't losing market share, and the market dynamics are stable, which suggests a forthcoming recovery. When that occurs, the productivity advantages we aren't currently benefiting from will become significant. I look forward to moving past our current challenges, and hopefully, as some predict, next year will bring improvements in the Industrial area, along with increased leverage tied to our investments and productivity initiatives.

Our next question will be from Mark Weintraub of Seaport Research Partners.

First question was, the RTS transaction getting completed. Obviously, the world's changed a little bit. OCC higher, URB a bit lower. Can you update us kind of on what type of accretion or EBITDA contribution in the current environment is it reasonable to be anticipating?

Yes, Mark, that's a good question. Really no change. I mean we've been really pleased with how those assets have come over to our portfolio. When we talked about it last year, we said it was $50 million of EBITDA with about $16 million of targeted synergies, but $10 million of those were kind of day 1 and what we're seeing is that those synergies are coming through day 1. So the business is performing well. I would say the TSA load is probably a little bit more than you probably were anticipating. We think that this is – that it's give or take $0.05, plus or minus a couple of cents, per quarter next year. And so we feel really good about how that's coming through and how the business is operating. And as Howard said, I think that that is additive to the system in this low volume environment because the mill is relatively covered, but it gives us more tons to spread across the system. So we feel really good about that.

Okay. Great. And that includes Chattanooga when you're talking in this conversation?

Yes, that's a good question. I was talking about both. I mean we think about it all as one kind of integrated transaction.

Got it. Makes sense. And then second, maybe what are some of the other actions that you're taking that can move the dial that are outside of business getting better that are going to be flowing through next year that you'd want to highlight as we think about bridging out '24 versus '23?

Mark, yes. We are continuing our journey that began about 3 to 3.5 years ago when we increased our capital investments to enhance productivity. Normally, a capital cycle can take 1.5 to 2 years, but COVID has extended that timeframe. We expect to see gradual improvements from those investments next year. We have also discussed the restructuring and how we are managing our business centrally, as well as the future of our portfolio. Over the last 18 months, we’ve been actively engaged in clearing the underbrush, which includes small divestitures and closing facilities that detract from our overall strategy. This process will keep going. When we meet in February, we'll present our current status; it won't be a case of mission accomplished, but rather an update on where we are now. I believe you'll be impressed with some of the restructuring initiatives we will announce then, as well as our plans for managing the company moving forward. Regarding financial modeling, I cannot provide specifics on how this impacts economic performance quarter-by-quarter or for the year, but I hope to share more information during our February meeting.

Okay. Fair enough. And just lastly, recognizing it's a dynamic environment, but given where tin plate is, et cetera, did you have a perspective on whether there's likely to be additional inventory impacts that flow through metal benefits or negative impacts next year? Or any help there? I mean it would seem like that could be another negative, but...

Yes, it's still early, and everyone is aware of the supply side issues, including tariffs and acquisition discussions, which are creating a lot of noise and causing delays in our negotiations. Therefore, it's premature to discuss the direct inflationary impact. However, I can say that from an inventory standpoint, our customer profile is looking much better. For instance, a major customer I met with a couple of weeks ago has reduced their inventory significantly, which has negatively affected us in the first half of the year. Now, we are observing that inventories are starting to normalize across the board. So regardless of any fluctuations in steel pricing, the overall impact should be less severe or negative since inventories at our customer locations have decreased.

And our next question will come from Gabe Hajde of Wells Fargo Securities.

This is Alex on for Gabe. I appreciate all the promise you guys made on Q4. But maybe just if I were to kind of think about 2024, can you kind of comment on how you're thinking about the working capital and your inventory?

Alex, for Q4?

For Q4 and 2024, if you can comment on that.

Next year's inventory.

For Q4, we have made a significant effort to reduce inventory, which is now over $250 million lower than before. We expect this level to remain stable until the end of the year, with a major portion of the decrease coming from metal. In terms of other working capital, we released $100 million in accounts receivable from Q3 to Q4, and while we do not anticipate this degree of release every year, it is part of our normal cycle. We plan to release another $100 million of accounts receivable in Q4, leading to a total reduction of approximately $148 million in working capital. Looking ahead to next year, we are actively managing inventory, accounts receivable, and accounts payable. We believe our current days metrics are appropriate, and we do not see a need to further decrease inventory, especially as some businesses are expected to grow next year. Therefore, we predict the working capital metrics will remain steady in 2024.

Okay. Can you just remind me again or remind us again what portion of COGS is labor?

Portion of the COGS? Can you say that again, Gabe? You're breaking up just a little bit.

Sorry. Can you just remind us again what portion of COGS is labor? And I guess, how should we kind of think about the mid-single-digit labor inflation next year? Do you have anything in your contracts to kind of pass this through to your customers through price increases?

We do have the opportunity to pass on labor, but we're having to carry it until those until the timing of price adjustment coming into place, typically quarterly. But certainly, labor inflation is continuing to roll over through this year and then early next year. So it will be a timing issue with the customers.

Okay. And sorry, lastly, just what portion of COGS is labor?

It varies by business. I mean, I'd say that in some businesses, it's in the 10% to 20% range most of the COGS is really material. And there's a component of that that certainly fits. But it's definitely less than 25% in every business and in some businesses, it's really in the single digits.

Thank you for joining us today. If you have any follow-ups, we'll be around after the call to answer your questions or please feel free to contact me to schedule a follow-up. We look forward to seeing you on the road at our planned conferences and events in the coming weeks, and we will look forward to reporting our fourth quarter and full year results on February 15, 2024. One week later, we will be having our Investor and Analyst Day on February 22, 2024 in New York, as Howard referenced. This will be an in-person event, and a webcast will also be available. Registration details for the in-person event as well as the webcast will be available on our website soon. And with that, we'll close the call, and hope you all have a great day.

This concludes today's call. Thank you for participating. You may now disconnect.