International Paper - Q1 2023
April 27, 2023
Transcript
Operator (participant)
My apologies. Ladies and gentlemen, good morning. Thank you for standing by. At this time, we would like to welcome everyone to The International Paper's Q1 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press one then zero on your telephone keypad. To withdraw a question, please press one then zero. We do ask that you limit yourself to one question and one follow-up question. It is now my pleasure to turn the call over to Mark Nellessen, Vice President, Investor Relations. Sir, the floor is yours.
Mark Nellessen (VP, Investor Relations)
Thank you, Leah. Good morning, and thank you for joining International Paper's Q1 2023 Earnings Call. Our speakers this morning are Mark Sutton, Chairman and Chief Executive Officer, and Tim Nicholls, Senior Vice President and Chief Financial Officer. There's important information at the beginning of our presentation on slide 2, 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-US GAAP financial information. A reconciliation of those figures to US GAAP financial measures is available on our website. Our website also contains copies of the Q1 earnings press release and today's presentation slides. I will now turn the call over to Mark Sutton.
Mark Sutton (Chairman and CEO)
Thank you, Mark. Good morning, everyone. We will begin our discussion on slide 3, where I will touch on our Q1 results. Let me begin the discussion by saying how proud and appreciative I am of all the hard work of our employees and for our strong customer relationships as we manage through a dynamic and challenging macro environment. Looking at our performance, International Paper delivered $65 million of year-over-year incremental earnings benefits from our Building a Better IP initiatives. Our mill system continued to perform very well as we successfully executed our highest planned maintenance outage quarter of the year and continued to optimize our system while taking care of our customers. On capital allocation, we returned $319 million to share owners during the quarter, including $157 million of share repurchases.
We continue to navigate a challenging demand environment as our customers and the broader supply chain work through elevated inventories of their products. We also believe consumer priorities remain focused on services as well as nondiscretionary goods, which has been influenced by inflationary pressures, rising interest rates, and the pull forward of goods during the pandemic. Margins were also under pressure from lower prices across our portfolio, partially offset by additional benefits from lower input cost.
Now I'll turn to slide 4 and talk more about the current operating environment as well as our ongoing commitments going forward. As we entered the year, we recognized there were macroeconomic uncertainties ahead of us, and our businesses are not immune to these risks. These macro trends shifted in the quarter, resulting in a weaker than expected demand environment through the first part of this year.
Much of this was influenced by greater inventory destocking across the whole supply chain, weaker export markets, and unfavourable weather impacts on the fresh produce segment. In addition, lower prices across our portfolio today have put additional pressure on margins relative to what we expected in our full year outlook. Although we believe most of the destocking through the retail channel has been resolved, destocking continues throughout the rest of the supply chain, especially with manufacturers and many of our customers. We believe this will run its course through the Q2, resulting in an improved demand environment in the H2 of the year.
I want to reinforce that our teams at International Paper know what it takes to successfully manage through a business cycle by leveraging the wide range of options and capabilities across our large system of mills, box plants, and supply chain to really variabilize our cost while continuing to take care of our customers' needs. We demonstrated our ability to do this in prior business cycles. Our ongoing commitment is to continue operating our company the IP way. We remain focused on our key priorities of taking care of our employees, our customers, and maximizing value for our shareowners. This includes preserving our strong financial foundation and maintaining our dividend. Before I turn it over to Tim, I also want to provide an update on llim. We have made good progress toward closing the sale of our llim investment.
Buyers received an important required approval from the Russian sub-commission overseeing exits by foreign companies, but we are still awaiting the approval of the Russian Competition Authority. We are optimistic that this final required approval will be received soon, and we plan to close shortly thereafter. I will now turn it over to Tim, who will provide more details about our Q1 performance as well as our outlook. Tim?
Tim Nicholls (SVP and CFO)
Thank you, Mark. Turning to our Q1 key financials on slide five. Revenue was down slightly versus prior periods while operating earnings per share came in above prior year and better than the outlook we provided last quarter. Operating margins in the quarter were impacted by weaker demand and seasonally high planned maintenance outages. Free cash flow for the Q1 included a use of cash totalling $193 million for the final settlement with the IRS related to our
Timber monetization actions we highlighted during our last earnings call. This settlement allowed us to further de-risk our balance sheet. About 31% of our annual capital expenditures occurred in the Q1. Moving to the Q1 sequential earnings bridge on slide six. Q1 operating earnings per share were $0.53 as compared to $0.87 from the Q4. Price and mix was lower by $0.10 per share due to the index movements across our portfolio. Lower export sales prices and unfavourable product mix in our Global Cellulose Fibers business as a result of lower absorbent pulp shipments.
Volume was flat sequentially as weaker demand and customer inventory destocking across both businesses was offset by four additional shipping days in our North American Industrial Packaging business. In our Global Cellulose Fibers business, the Q1 was also lower due to the Chinese New Year.
In operations and cost, our mills ran very well. quarter-over-quarter was unfavourable because the Q4 benefited from favourable one-time items totalling $71 million or $0.15 per share, related to lower employee benefit costs, workers' comp expenses, and medical claims. Our Cellulose Fibers business was impacted by higher economic downtime due to the lower demand environment I mentioned earlier. Maintenance outages were higher in the Q1 as planned, we saw significant relief from input costs, which were $134 million or $0.28 per share lower in the Q1, primarily driven by lower energy and OCC costs. Corporate and other items was impacted by FX and timing of spend, partially offset by a lower tax expense. Turning to the segments and starting with Industrial Packaging on slide 7.
Price and mix was lower due to index movements and lower export prices. This was partially offset by benefits from commercial mix initiatives focused on margin improvement. Sequentially, volume benefited from four additional shipping days. However, demand for packaging weakened in March across most channels and segments from lower consumer demand and ongoing destocking across the supply chain. Even in this dynamic demand environment, International Paper is well-positioned due to our diverse portfolio of products and services and our strategic relationships with a large number of national and local customers across a broad range of attractive end segments. Sequentially, ops and costs were impacted by the non-repeat of approximately $57 million of favourable one-time items I mentioned earlier, as well as timing of spend. Overall, our mill system ran very well.
The lower demand environment impacted operations and costs in the quarter as we adjusted our system to align our production with customer demand. These actions resulted in approximately 421,000 tons of economic downtime across the system. Input costs were significantly lower and improved earnings by $105 million sequentially. Almost 2/3 of the benefit was from lower energy costs in North America and Europe, and the remainder was primarily from lower OCC and freight costs. Overall, we continue to face very elevated supply chain costs, as well as the impact from high inflation on materials and services during the past couple of years. In a lower demand environment, we aren't running at full capacity. We believe there is a large opportunity to further optimize our system and take out high marginal costs. This remains a key lever in 2023.
Turning to slide 8, we thought it'd be helpful to share some additional perspective on underlying segment trends for our corrugated packaging business. As shown on the previous slide, our U.S. box shipments were down 8.5% year-over-year in the Q1, and down almost 12% year-over-year in the month of March. We saw demand decline across all end-use segments on a year-over-year basis and experienced another demand shift in March that impacted all segments except for e-commerce. Furthermore, demand declines were more pronounced in segments that generally are more discretionary in nature as consumers had to make choices while dealing with high inflation and rising interest rates.
The yellow indicators represent segments where the demand decline was less than our overall average of 8.5%, and the red indicators represent declines that were greater than the average decline. For example, processed food and protein were more resilient, down low to mid-single digits as consumers focus on essentials and value, and poultry serves as a low-cost consumer staple. Fresh produce was impacted by poor weather conditions on the West Coast and also in Florida. On the other side of the spectrum, segments like durables and other non-durable consumer goods are more discretionary in nature. Along with shipping and distribution, these segments came under the most pressure with declines in the mid-teens. These segments also tend to be more affected by the inventory destocking efforts across the longer supply chains.
E-commerce was down mid-single digits versus last year, but showed more resilience through the quarter and is still up 50% from pre-pandemic levels. Based on feedback from our customers, we believe the majority of retailer inventory destocking has been completed through the Q1. Manufacturers are still reducing inventories as a result of lower demand levels, improved supply chain velocity, and focus on working capital given higher interest rates. We also believe the majority of destocking will be completed in the H1 of the year. Considering our performance in April and looking at order backlogs, we expect sequentially higher volume in the Q2. Despite these near-term headwinds, we understand the critical role corrugated packaging plays in bringing essential products to consumers, and believe that IP is well-positioned to grow with our customers over the long term. Moving to cellulose fibers on slide 9.
Taking a look at our Q1 performance, price and mix was relatively flat sequentially. Our strategic initiative related to contract restructuring generated significant earnings improvement in the Q1. This was offset by a less favourable mix due to lower fluff volumes in the quarter and a higher % of commodity grades, as well as the unfavourable impact from index movements. Volume was lower due to customer inventory destocking in response to improvements in the supply chain velocity from less port congestion and improved vessel reliability, and also impacted by the Chinese New Year. Feedback from our customers suggests the majority of destocking will be completed in the Q2. With that said, we believe fluff demand will continue to grow over the long term. This is due to the essential role that absorbent personal care products play in meeting consumer needs.
The lower demand environment significantly impacted operations and costs in the Q1 as we adjusted our system to align our production with our customer demand. These actions resulted in approximately 130,000 tons of economic downtime across the system, and accounted for approximately 2/3 of the ops and cost variance. Sequentially, ops and costs were also impacted by inflationary pressures, as well as the non-repeat of approximately $14 million of favourable one-time items in the Q4 that I mentioned earlier. Planned maintenance outages were higher by $11 million sequentially, and represents one of the highest outage quarters of the year. In addition, input costs were lower by $29 million due to lower energy and fiber costs. Turning to slide 10, our Global Cellulose fibers business continues to make progress executing our strategy to deliver value-creating returns over the business cycle.
The business increased earnings by approximately $100 million in 2022 and is focused on driving incremental earnings growth this year, despite operating in a more challenging macro environment. Our team successfully deployed a commercial strategy focused on building strategic relationships with key global and regional customers and aligning the most attractive regions and segments. In the Q4, we finalized our fluff pulp contract negotiations, which is contributing meaningful commercial benefits this year.
Going forward, we believe there are significant opportunities to improve our cost to serve by reducing supply chain costs, which had increased significantly during the past couple of years. We expect to see these benefits will start to show up in our Q2 outlook. We are focused on creating value for our customers by delivering products that meet their stringent performance and product safety standards and deliver innovative value.
In addition, we are driving structural margin improvement by ensuring we get paid for the value we provide. We believe this is reflected in the premium we earn for fluff pulp over commodity grades, which has expanded over time. We are committed to building on this momentum and expect to drive additional earnings growth going forward. Turning to slide 11, I'd like to update you on the Building a Better IP initiatives. We're making solid progress and delivered $65 million of year-over-year incremental earnings improvement in the Q1.
Our lean effectiveness initiative was mostly completed early in the program, generating $110 million of cost savings since we began our Building a Better IP program. By streamlining our corporate and staff functions to realign with a more simplified portfolio, we more than offset 100% of the dyssynergies from the printing paper spinoff.
The most significant driver of the year-over-year results was strategy acceleration, as we delivered profitable growth through commercial and investment excellence. As I mentioned earlier, I generated solid earnings growth in our Global Cellulose fibers business on a path to deliver value-creating returns. We are also focused on profitably growing our Industrial Packaging business by improving margins and investing for the long term. The process optimization initiative has the potential to reduce costs across areas such as maintenance and reliability, distribution and logistics, and sourcing as we leverage advanced technology and data analytics. We believe these initiatives will deliver meaningful benefits going forward as we finish implementing new capabilities across our business. Turning to slide 12, I wanna take a moment to update you on our capital allocation actions.
As Mark highlighted earlier, we have a very strong balance sheet, which we will preserve because we believe it is core to our capital allocation framework. Our 2022 year-end leverage was 2.1 times on a Moody's basis, which is below our target range of 2.5 to 2.8 times. Looking ahead, we have limited medium-term debt maturities. Finally, even in this environment, the risk mitigation strategies we've taken help ensure our pension plan remains fully funded. Returning cash to shareholders is a meaningful part of our capital allocation framework. In the Q1, we returned $319 million to shareholders, including $157 million through share repurchases, which represents 4.3 million shares or about 1.2% of shares outstanding. At the end of the quarter, our total authorization was approximately $3 billion.
Going forward, we're committed to returning cash through maintaining our dividend and through opportunistic share repurchases. Investment excellence is essential to growing earnings and cash generation. We invested $341 million in our businesses in the Q1, which includes funding for cost reduction projects with attractive returns and for our strategic projects to build out capabilities in our box system. Going forward, we plan to make additional investments across our box system to support long-term profitable growth, and we will remain disciplined and selective when assessing M&A opportunities. Turning to slide 13 and our Q2 outlook. I'll start with Industrial Packaging. We expect price and mix to decrease earnings by $110 million, mainly as a result of prior index movement in North America and lower average export prices based on declines in the Q1.
Volume is expected to increase earnings by $30 million due to normal seasonal increase in daily shipments to North America, offsetting one less shipping day. Operations and costs are expected to decrease earnings by $35 million due to the timing of spending. Maintenance outage expense is expected to decrease by $10 million. Q2 should represent approximately 30% of the total planned outage cost in 2023. Through the H1 of the year, we will have completed about 70% of expected annual outages. The Q2 includes approximately $19 million of spend associated with the Riverdale Mill printing papers outage. This cost will be fully recovered as part of the charges to Sylvamo over the course of the year. Lastly, input costs are expected to decrease by $30 million from lower average cost for energy and freight.
Switching to Global Cellulose fibers, we expect price and mix to decrease earnings by $45 million as a result of prior index movements. Volume is expected to increase earnings by $5 million, primarily based on seasonally higher demand. Operations and costs are expected to increase earnings by $40 million due to lower supply chain costs and lower unabsorbed fixed costs from higher volume. Maintenance outage expense is expected to decrease by $33 million. Lastly, input costs are expected to decrease by $15 million, mostly due to lower energy and fiber costs. Moving to our full-year outlook on slide 14. As Mark discussed earlier, as we entered the year, we recognized there were macroeconomic uncertainties ahead of us and that our businesses are not immune to these risks.
The macro trends have shifted, resulting in weaker than expected demand for our products and price reductions across our portfolio through the Q1, including prior index changes that will be implemented over the remainder of the year. As a reminder, our previous outlook represented price indexes at that time. We are now projecting full-year 2023 EBITDA for the company to be in the range of $2.3 to $2.5 billion. We continue to optimize our system by reducing high marginal costs and driving additional benefits from our Building a Better IP initiatives. This includes delivering continued earnings growth in our Global Cellulose fibers business despite cycle headwinds. I would also note that our outlook includes only the impact from published price changes to date.
Free cash flow is expected to be $800 to 900 million, which includes a one-time tax payment of $193 million in the Q1 related to our timber monetization settlement. In addition to free cash flow, we also expect to receive approximately $500 million of cash proceeds from the llim sale. For 2023, we are targeting CapEx of $1 to 1.2 billion with increased investments in our U.S. box system to build additional capabilities and position us for long-term profitable growth with our customers. We will also focus on high return cost reduction projects across our systems. With that, I'll turn it back over to Mark.
Mark Sutton (Chairman and CEO)
Thanks, Tim. Now I'm going to turn to slide 15. I want to reinforce my confidence in the resiliency of IP and our ability to navigate through this dynamic environment from a position of strength. As I mentioned earlier, our teams at International Paper know what it takes to successfully manage through a business cycle. By leveraging the wide range of options and capabilities across our large system of mills, box plants, and supply chain to optimize our costs while continuing to take care of our customers. Also, we are well-positioned due to our diverse portfolio of products and services and our strategic relationships with a large number of national and local customers across a broad range of attractive end-use segments. Finally, we have significantly enhanced our financial strength and flexibility.
The strong foundation that we have built makes IP well-positioned for success across a wide spectrum of economic environments, and to deliver profitable growth over the long term. With that, we're gonna move to Q&A, and I'd like to note that I've invited our senior business leaders to join me for this portion of the call. Given the dynamic environment we're in, I thought it would be helpful for you to hear some additional perspective from these leaders. Operator, we are ready to go to questions.
Operator (participant)
Thank you. Ladies and gentlemen, if you would like to ask a question, simply press one-zero on your telephone keypad. If you would like to withdraw a question, press one-zero. We do ask that you limit yourself to one question and one follow-up question. One moment, please. Our first question comes from the line of Anthony Pettinari with Citi. Please go ahead.
Anthony Pettinari (Managing Director and Senior Equity Analyst)
Good morning.
Mark Sutton (Chairman and CEO)
Go ahead.
Anthony Pettinari (Managing Director and Senior Equity Analyst)
Hey, Mark, you know, Tim, you talked about, you know, confidence in Global Cellulose fibers earnings growth this year. You know, assuming the list prices that have been published, I guess as of, you know, today, what gives you confidence that, you know, we won't either see, you know, further meaningful deterioration in fluff prices or, you know, the confidence that you have, you know, the offsets like the commercial initiative to kind of offset, you know, any further deterioration? I'm just wondering if you can give us kind of any sense there. If you can kinda remind us the lag from, you know, price change in the pulp index to your contracts and earnings.
Mark Sutton (Chairman and CEO)
Okay. Great question, Anthony. I'm gonna take the first part of that, and then I'm gonna ask Clay Ellis, who leads our Global Cellulose fibers business, to give you a little perspective on some of the changes we made. I mean, the source of our confidence is we've really changed the way we go to market. As we've explained many times, there's this contract portion which is generating significant earnings uplift in the contract large global multinational customer base. There is a portion of our business that's open market, that's traded more monthly or shorter term, less contractual, that's also absorbents. We have a specialty business that's not tracking exactly those markets.
The last piece, which is the most volatile, we still have exposure to market pulp, which is where a lot of the pricing issues have hit the business and will likely hit the business. If we focus on the core, that's where our confidence is around the absorbent strategic customers and the profit improvement and the changes we made really in the last 18 months that are coming to fruition. As far as the flow-through and a little bit more about how we see the year happening, there's a story similar to what I described in my prepared remarks and what Tim described with destocking and where we think demand, the real demand from the end-use customer is gonna go. Clay, I'd ask you to maybe add some color to that.
Clay Ellis (SVP, Global Cellulose Fibers)
Sure, Mark. Yeah, Anthony, good question. Just to hit the lag time that you mentioned. You know, in around a quarter, if you think about our index pricing, just think around a quarter lag in general. Around what gives us confidence, I think, you know, Mark was hitting on it there. Our end-use demand of absorbent hygiene products, we see our customers see is still solid. I was in Geneva last week at a index conference where we had many of our customers, talked to many of our large global and also all the way to some small regional. Across the board, it's the same outlook on what consumers are doing in this space on absorbent is good and the outlook is strong and would think about historical levels of growth.
This inventory destocking is the story. It's what's happened. It's certainly more than we expected, a little longer and deeper. We do expect it to come mostly to an end in the Q2. H2 gives us confidence, returning to normal, more normal volumes, improved mix, and then also the economic downtime that we're experiencing in the H1 should largely be gone by then, and we expect to be able to drive profitable growth even over last year.
Anthony Pettinari (Managing Director and Senior Equity Analyst)
Okay. That's very helpful. You know, switching to Industrial Packaging, you talked about, you know, confidence that destocking could run its course in the Q2 or by the end of the Q2. I guess that's a comment on the domestic market. I'm wondering, you know, when you think about the export channel, which I think you indicated remains weak, is it possible to think about sort of where customer inventories are there? Is there any sort of light at the end of the tunnel, or regions that are maybe improving or maybe getting worse? I don't know if there's any general comments there.
Mark Sutton (Chairman and CEO)
Yeah. That's a great question, Anthony. You're right. Both Tim and I's prepared comments were primarily focused on the largest market we're in, which is North America. Jay Royalty's here. Jay runs our global containerboard business as well as our EMEA packaging business. I think Jay has been working very feverishly with the teams to try to understand just that. Jay, if you wanna comment a bit on Anthony's question about export markets and the non-U.S. phenomena of destocking and demand.
Jay Royalty (SVP, Containerboard and Recycling)
Sure, Mark. Hi, Anthony. I think, you know, when you look at the export channel, it's been and remains particularly weak. You know, we've seen very low demand for the last several months due to a lot of different factors, whether it's geopolitical, high inventory levels, low consumer activity as it relates to inflation. Also, you know, weather for fruit and vegetable goods has been not cooperating really around the globe, the U.S., Europe, even into places like Morocco. We are seeing inventory levels improving and, you know, we can start to see some stabilization there. In terms of any signs of improvement, I think those are few and far between, maybe a little bit in Latin America, which is one of the markets we serve.
you know, these markets will rebound at some point. you know, our positions across Europe, Latin America, Asia, these are with customers who really value kraft linerboard, heavily oriented to fruit and vegetable segments. and those are gonna grow with consumer activity and consumption over time. you know, we feel good about the future, but certainly in this moment, it's particularly weak, and that's putting pressure on both demand as well as pricing.
Anthony Pettinari (Managing Director and Senior Equity Analyst)
Okay. That's very helpful. I'll turn it over.
Operator (participant)
Our next question is from Matthew McKellar with RBC Capital Markets. Please go ahead.
Matthew McKellar (VP and Senior Associate)
Yeah, thanks very much. I was wondering if you could add a little bit of just colour in terms of what you're seeing in demand in the Industrial Packaging business to start Q2, maybe compared to both March and Q1 as a whole. Particularly thinking about, you know, your different customer segments and where you're seeing areas of relative strength and weakness.
Mark Sutton (Chairman and CEO)
That's a great question, Matthew. This is Mark. I mean, we look at demand in two components. There's the final end-use consumer. I think we term that, our marketers term that organic demand. There's the demand ahead of that in the manufacturers and the supply chain ahead of the consumer. Those manufacturers are really our customers. When you break it down by segment, Tim had that colourful chart where he looked at the broad segments. Tom Hamic, who leads our North American box business, is here, and I'd ask him to give some insight on your question about how we see it going forward, what gives us confidence on our comments about the destocking piece, and then maybe some segment comments, Tom.
Thomas Hamic (SVP, North American Container and Chief Commercial Officer)
Sure. Thanks, Mark. Good morning, Matthew. You know, we exited or entered the Q2 very strong relative to March. We've got good momentum moving from March to April. You know, you could think about shipments being up, maybe 5% to 6%, and our backlogs are actually better than that. We see that almost double-digit improvement in backlogs. I think that indicates how we've thought about destocking, is it's not gonna go away immediately, but it is going to transition through the Q2. Because as Mark mentioned and Tim mentioned, different segments have different levels of destocking that they're having to work through. It's, it's not a uniform everyone has too much in inventory. It's, it depends on the segment and if it's perishable goods or something like that.
I think our confidence in understanding destocking is we triangulate between macro data, a lot of customer conversations about what they're seeing in the near term, as well as our experience in these segments over time and how they're growing and how we understand their supply chain to work. On a positive sense, all of those point us in the same direction as this plays out through the Q2. Obviously, there's a component of that that's demand dependent, but in large part, we feel good about the momentum for where the box business is headed.
Matthew McKellar (VP and Senior Associate)
Great. Thanks. That's helpful. Then shifting over, can you give us a sense of how you're thinking about share repurchases here? Should we continue to expect them to sort of trend in line with Q4 and Q1 levels? Do you maybe see more limited room for repurchases given the downward revision to free cash flow outlook? Do you even accelerate repurchases given where the shares are trading? Thanks.
Tim Nicholls (SVP and CFO)
Hey, Matthew, it's Tim. I would just step back from the specific on share repurchases and say you I think you're familiar with our capital allocation framework, and we take that into consideration across all the uses of cash in everything that we do. As Mark said, you know, starting with a strong balance sheet, it gives us tremendous financial flexibility. Maintaining the dividend is a complete commitment. We target opportunistic share repurchases. We're constantly looking at the environment, and in any moment in time, we're making, you know, decisions around where is the best place to deploy cash for value creation and maximization. Nothing's gonna change in terms of how we think about that framework through the cycle. You know, all parts of the cycle that comes into consideration.
Matthew McKellar (VP and Senior Associate)
Okay, thanks. I'll turn it back.
Operator (participant)
Our next question is from Gabe Hajde with Wells Fargo Securities. Please go ahead.
Gabe Hajde (Equity Research Analyst)
Mark, Tim, good morning. Thanks for taking the question.
Mark Sutton (Chairman and CEO)
Morning.
Gabe Hajde (Equity Research Analyst)
I wanted to revisit, I think, Tim's prepared remarks on slide 7. I wanna make sure I heard what you wanted us to hear, which was, I think, you talked about facing higher supply chain costs and in sort of the current low environment, there was, I think, Tim, your words were further opportunity to optimize the system. I'm assuming that means, you know, continue to take out variable costs of the system, or has there been sort of a change in philosophy in thinking about you know, your mill system or maybe the box system overall where you can make some permanent adjustments?
Tim Nicholls (SVP and CFO)
No, you had it right. I mean, we're talking about how we run the system we have as efficiently as possible. When you're taking this amount of downtime, you're constantly trying to optimize on the marginal cost and get out the high marginal cost. It's a, it's something that we started. Well, we started years ago, but more recently we started looking at marginal cost in the H2 of last year and it continued in the H1 of this year. Just given the dramatic nature and shift in demand and the way we've responded, it's taken a little bit more time than normal, but we're starting to see how it plays through in not only in inputs and buying the highest cost inputs, but now into transportation as well.
it's a real focus on just getting out as much cost as possible.
Mark Sutton (Chairman and CEO)
Yeah, Gabe, you know, sometimes, this is Mark, sometimes we get, and we may get it later in the call, we get a question about would we consider changing the way we operate in lower demand environments versus the current approach to running most of our system at different levels of output instead of running part and not running part. We evaluate that on, I mean, really almost on a continuous basis. Depending on what's happening, as Tim described, the supply chain environment we're in and then the cost gradient we have at most of the mills on fiber and OCC and other inputs, there is huge savings for eliminating the high marginal cost across, you know, 17 different mills.
You can imagine if you decided to, you know, temporarily close one or two of them, then you have to add back all that marginal cost at the others, 'cause in theory, they're gonna run full. Depending on geography and logistics, you end up with no net savings. We are continuing to look at that. We have gotten. I didn't think we could get a lot better, but our teams have gotten better at marginal cost takeout across systems running, you know, much lower than full capacity. We don't take anything off the table in terms of figuring out the best way to operate, you know, for the, for the quarter ahead or the two quarters ahead with the best information we have about the demand signal.
It's really an optimization of the total cost, and the value in that marginal cost reduction is really powerful.
Gabe Hajde (Equity Research Analyst)
Thank you for that. I guess, a little bit more short-term in nature here. You talked about input costs being $30 million favourable in Industrial Packaging. I suspect that an element of that is maybe lower natural gas. Do you have an explicit assumption for kinda OCC hovering where we are today? You know, I sort of ask the question because one of your peers talked about some pretty healthy rail price increases that came into effect April 1. Curious if that's something that impacts you. Sort of for the implied H2 guidance, is there anything explicit in there that you would instruct us towards in terms of underlying assumptions for some of your bigger inputs, whether it's again, virgin fiber, recycled fiber, or energy?
Tim Nicholls (SVP and CFO)
Yeah. Hi, it's Tim again. I think the headline is we're not. Q2 is going to be better. It depends on which category of input costs that you're talking about. On natural gas, we pretty much follow the strip. There's some distribution charges and things like that that impact it, but the movement is very similar. You can see how that plays out. On OCC, we have a modest we believe there could be a modest increase over time, but the whole environment is so fluid and dynamic, it's gonna depend on what how it plays out over this quarter and as we go into the Q3. Chemicals for us are getting a little bit better.
Transportation, I don't know the reference you mentioned on the contract. These contracts come and go at different points in time, and it's a mixture across all the modes of transportation that we're seeing. I'd say on balance, we get another benefit on input costs in the Q2. Depending on the scenario, it's kind of flattish as you go out through the H2 of the year. There's a small pickup, but again, it's gonna depend on the backdrop.
Gabe Hajde (Equity Research Analyst)
All right. Thank you for that, and good luck.
Operator (participant)
Our next question is from Kyle White with Deutsche Bank. Please go ahead.
Kyle White (Equity Research Lead Analyst)
Thanks. Good morning. Thanks for taking the question. Just wanted to go to the outlook and was wondering if you can kinda walk us through some of the moving parts, regarding the new updated outlook versus the initial target. Any way to kinda size how much of that reduction is driven by the corrugated packaging business versus cellulose fibers? How much is driven by the change in pricing versus maybe, you know, the weaker demand environment that we're in?
Tim Nicholls (SVP and CFO)
Yeah. You're talking about the 2.8 versus the new range of 2.3 to 2.5, Kyle?
Kyle White (Equity Research Lead Analyst)
Yeah, that's correct.
Tim Nicholls (SVP and CFO)
Yeah. It's Tim. March was, I think there's no other way to say it. It was a surprise to us in terms of demand drop-off and the resulting economic downtime that we took to balance out our system. You know, when you look at it, we had further price, published price, decreases for pulp. Export prices came down.
We had lower volume and we had more ADT, which means more cost. You look at how that evolves as we go through the Q2 and the H2 of the year, those things are going to be present. We also get, as I mentioned, a little bit better on input costs. We have a significant drop off in maintenance outages because we're really front-end loaded, front-half loaded on our maintenance outages. There's some additional costs that come out. When we looked at all of it, there were some pretty significant moves in the month of March that even though it's getting better, you know, still impact the first part of the Q2.
Kyle White (Equity Research Lead Analyst)
Got it. I guess if we go back to last quarter, I think you guys talked about box shipments potentially being able to come back to being flat for 2023, and that was assumed in maybe the outlook that you had initially. Obviously, destocking has been a little bit more than everyone had anticipated and provided for a weaker demand environment. Are you able to kind of help us understand what is embedded in terms of the new outlook on where you think box shipments could be for the full year now?
Thomas Hamic (SVP, North American Container and Chief Commercial Officer)
Sure, Kyle, this is Tom Hamic again. You know, our view on boxes, and we say this a lot, is that economic activity drives box demand. As we see the economy recover, we expect box demand to tie directly to it. There really isn't a near-term substitute for a box when you're thinking about delivering to a retail channel or to really any channel in the U.S. We're confident about that rebound. I would say in terms of the full year, most of the difference we have between what we thought for the full year and what we think now is happening in the H1 due to this destocking. It's really hard to forecast the full year exactly.
I think it's gonna depend on us being correct about the Q2 and the destocking playing out, because the economy is also gonna be an open question. In general, we see this improving.
Kyle White (Equity Research Lead Analyst)
Got it. That makes sense. I'll turn it over.
Operator (participant)
Next we go to Mark Weintraub with Seaport Research Partners. Please go ahead.
Mark Weintraub (Senior Analyst and Head of Business Development)
Thank you. Obviously one of the concerns investors have had is about the new supply that's coming into the market in containerboard. Particularly thought we'd try and take advantage of the fact that you've got some industry leaders on the call. Just get any update on your thoughts as to how that capacity perhaps is right now. Is it already being absorbed and/or things to think about how that might play out as you see it?
Jay Royalty (SVP, Containerboard and Recycling)
Yeah, Mark, this is Jay Royalty. Good to talk to you. You know, I think that a few things to keep in mind relative to you know, this new capacity that's coming in. First of all, you know, the open market is relatively small, as you know. Our position in that market is really made up of long-term strategic relationships and including, in some cases, some equity positions. We've got very little spot business. It's important to remember that at the end of the day, people buy boxes and, you know, all, you know, they don't buy containerboard. Producers may buy some containerboard, but at the end of the day, it's about having an integrated system, which is what we have. Customer needs are complex.
You think about what, you know, customers value and what they're looking for and what IP brings to customers. You know, it's about comprehensive offerings. There's a wide grade mix there, geographic reach, you know, redundant capabilities, having the ability to surge and flex with their needs. All of these things are important. You know, it's really about more than a single mill. It's about having a system and those capabilities, and that's what customers value. When you think about our relationships, you know, our customers are looking for those things. That's what allows us to have these long-term, strong relationships. You know, the new entrants are gonna be trying to compete with that in some form or fashion.
Mark Weintraub (Senior Analyst and Head of Business Development)
Okay, that's helpful. Thanks, Jay. Just maybe if I could follow up on the distinction between the shipments, which I think you mentioned were up 5%, 6% so far in April, so encouraging, and then backlogs being up double digits. What should we make of that? What does the backlogs, is that a lead indicator for where shipments likely would go to? Recognizing we've had some very difficult demand environment, so we don't wanna get ahead of ourselves. Could this mean that we're actually closer to being through on the destock? But, you know, why that's sort of the conservativeness, again, what we've gone through good and reason enough right there.
Just trying to get a little bit more color and thoughts on the shipments and the backlog data you were talking about for April to date.
Thomas Hamic (SVP, North American Container and Chief Commercial Officer)
Sure, Mark. This is Tom again. Just for some clarity that you had it right. The shipment comment I had was about 6%, and that's sequential from March. Obviously, as Tim talked about earlier, March was weaker than the Q2, but it's still a strong sign of momentum. Backlogs tend to be more volatile because as the market gets better, you get more and more orders because customers see that lead times are normalizing. It's a good indicator more of the future than it is in the moment. I think you combine the shipment outlook we have with the backlogs including,
We're probably pretty close on the Q2 playout that Mark and Tim talked about, because if we're not seeing it in this month, you probably have a bit of a delay. It feels like to me, it all fits together, and that's what we're hearing from customers.
Mark Weintraub (Senior Analyst and Head of Business Development)
That's super. One real quick follow-up then. Have you seen in the last, say, six months when we've been in this really difficult demand environment, have you seen where the shipments and backlogs went up and then they just roll back over again? Is this the first time you've really seen this?
Thomas Hamic (SVP, North American Container and Chief Commercial Officer)
I think this is the first time we've seen a significant shift from what you would think about seasonally. You certainly can have a segment that changes, and it might affect, if it's big enough, it might affect your total mix. I would say we have. Thinking about it, I, you know, don't have the numbers in front of me. I don't think we've had a false start.
Mark Weintraub (Senior Analyst and Head of Business Development)
Okay, super. Appreciate it.
Operator (participant)
Next, we go to the line of George Staphos with Bank of America. Please go ahead.
George Staphos (Managing Director and Senior Equity Analyst)
Hi, everybody. Good morning. Thanks for the details. Jay and Tom, good to hear your voices. Hope you're doing well. I had some technical difficulties getting on the call, and you may have mentioned this, but the last call in our Q&A, you had suggested that fluff, GCF could see, you know, roughly a $200 million improvement in profitability. Is there an update to that? Kind of the granularity, if I look at the waterfall and your outlook, and I look at what maintenance is going to look like sequentially the next couple quarters in GCF, I don't get much of an improvement in earnings this year. Just thinking about what is the Embedding your guidance for GCF, where should we see earnings, you know, move?
As we sit here today realizing destocking has been a big factor, and hopefully the revision of that will allow earnings to improve. Talk about why you still see this as a real good business to have for IP to be in for its shareholders, Mark, structurally. That a question on containerboard.
Mark Sutton (Chairman and CEO)
Okay, George. Thanks. Great question. Let me just hit the headline, and then I'll ask Clay to comment on what's embedded in our outlook and really ask him to remind and separate the absorbent and specialty core part of the business, and then the rest of the business, which tends to be more volatile than commodity. The 200, you know, had certain assumptions aligned with it. Some of those assumptions have changed. We still see line of sight to somewhere in the neighbourhood of $50+ million improvement in the business. There's still gonna be earnings improvement in the business. We just have to, you know, adjust what the timing of those improvements are given the change in some of the pricing assumptions and the way we're operating.
Clay, you might wanna talk a little bit about the puts and takes that make up that full year outlook.
Clay Ellis (SVP, Global Cellulose Fibers)
Yeah. Thanks, Mark. Hey, George,
George Staphos (Managing Director and Senior Equity Analyst)
Hey, Clay.
Clay Ellis (SVP, Global Cellulose Fibers)
You mentioned you may have missed some of the early part, but just to kind of tread a minute on, you know, what we see causing the issue in the H1 is almost all destocking. We do have a lot of confidence in the end-use consumer demand of absorbent hygiene products, and we see that future being a lot like historical in growth. So, you know, while we're confident about it or excited about it, this is a very in the moment kind of current issue, really an unprecedented issue with the inventory flow through. We believe we'll come out of that, have a stronger H2. You made mention of the $200 million from the last call.
Those changes have been made, and they're flowing through, in the pricing. That's there. You know, with the low volume that we've had, the low customer order rate, taking the EDT that we're taking, the price moves, it has eroded about $150 million of the $200 as we see as those prices flow through the year. To Mark's point, the $50 million still accretive to last year earnings is what we see on top of $100 million in 2022 versus 2021. We're confident as we get...
That the consumer demand is there, we get through this issue, we'll get our volumes more normalized, our mix more normalized, get away from the EDT cost that Tim had mentioned. We feel confident, we feel strong about it moving forward.
Mark Sutton (Chairman and CEO)
George, I'll just wrap the question you asked, the last part about why we still believe it's a good business and a good thing for IP shareholders. I mean, when you look at the business that we're in now, corrugated packaging, cellulose fibers for absorbent products, we've got two natural resource-based businesses, both facing growing end-use markets, both directly in our wheelhouse from a manufacturing and process standpoint. When you then layer out, forget about the product and look at the customer and the supply chain, you layer out the types of customers and what they value: solutions, technical design, the same kinds of things they value in the box business, they value in the cellulose fibers business. It's a more global customer base in cellulose fibers than it is in our box business.
We believe that starting with that softwood fiber, renewable, a very, very good, well-positioned manufacturing base, turning that into products that are facing growing markets is giving IP a higher quality of value creation than a, you know, single product line type of company. We believe that that's valuable in the long term. We don't think about just single moments like one year or a couple of quarters. We look at this down the road over the next decade, where are things headed? Where are the types of products that both businesses are making, are headed? We think that's exciting for investors as they sort out where sustainable natural resource type companies fit in their portfolios.
George Staphos (Managing Director and Senior Equity Analyst)
Thanks, Mark. On packaging, recognizing ultimately customer spec boxes, the box spec then dictates the substrate and the sheet of paper you're going to run on the corrugator to make the box and everything else that follows. Given that we've seen the cost curve shift a bit towards recycled versus virgin in terms of who's lower on the cost curve right now, and also given the shifts that are occurring in the end markets where, realizing this is really kind of a one quarter issue, not a structural issue. Nonetheless, we're seeing weakness in durable goods, weakness in ag. Is there anything we should take away about what your mix might look like in industrial over the next two, three quarters or more structurally?
Do you think relative to the mill fleet, relative to what you're doing on converting, do you think your mix of business will be as rich, if not richer, over time, than what we've seen in the last couple of years? Thanks. Good luck in the year.
Thomas Hamic (SVP, North American Container and Chief Commercial Officer)
Yeah, sure, George. This is Tom.
George Staphos (Managing Director and Senior Equity Analyst)
Hey, Tom.
Thomas Hamic (SVP, North American Container and Chief Commercial Officer)
You talked about. Hey, how are you? You talked a little bit about the different substrates, and I think as a customer of the containerboard system, that's a huge advantage for us because we've got this huge base of manufacturing different products, different grades. Since we have direct access to those, we can design the box and the box plant mix directly around that. In terms of the, you know, the destocking and how we feel about these different segments, I think we're gonna see different levels of destocking by segment like we talked about. I think we should expect a normalization of demand because the U.S. economy is gonna recover. That may take a little longer given economic conditions, but certainly it's coming.
Maybe a little bit of a specific piece to your question is, one of the biggest improvements we've seen coming into April is in ag. That has been a really tough business because of weather over the last couple of quarters, and we're starting to see that pop back up, which I think is a very good sign.
Mark Sutton (Chairman and CEO)
George, I'll just end Tom's comments with the, you know, the long-term question you asked about do we see our mix as a richer mix for the whole value chain, the packaging paper, the containerboard we make and the types, and then the ultimate box and packaging solution we provide. Our strategy is pointed to a richer mix over time, and our mill system will evolve in the type of products we make. Where we make them, we've got a heavy concentration in the southeastern part of the U.S., but we've got a market that covers the entire, you know, of North America, really. You'll probably see in the future, slightly different locations over time and probably definitely higher quality recycle being feathered into our mix.
I'll point to our most recent containerboard investment is a game-changing level of quality white top liner that brings us into a whole new set of segments where we were purchasing some of that paper before. It was good paper, and we were making some ourselves, which was second tier, and now we have some of the best printable white liner. You'll only see investments that incrementally improve us on quality and product capability, which again, to Jay's point, only matters if you turn it into a box that people want and are willing to pay for. That's the focus. We see the business getting better over time with a richer mix and a good end-to-end from natural resource to finished product value chain that we can be the best at every part of that for our customers.
George Staphos (Managing Director and Senior Equity Analyst)
Thank you very much.
Operator (participant)
Our final question for today comes from the line of Phil Ng with Jefferies. Please go ahead.
Phil Ng (Managing Director)
Hey, guys. Thanks for fitting me in. Despite a pretty challenging backdrop, Tim, the free cash flow is still showing to be pretty resilient here. You should be getting I believe $500 million cash proceeds from llim. Curious, what's the game plan in deploying that excess cash, hopefully coming very soon?
Thomas Hamic (SVP, North American Container and Chief Commercial Officer)
Yeah. Hey, Phil, it is Tim. It's like we always do. We have our capital allocation framework, and we look at where we are in the moment and then make decisions on how to best deploy cash for value. It'll be the same type of construct, as free cash flow comes in and incremental cash from llim.
Phil Ng (Managing Director)
Gotcha. Okay. That's helpful. From a pulp side of things, you know, marketed pulp prices, certainly seeing some pressure. Curious your confidence in maintaining that large premium versus fluff? Supply chain logistics certainly was very choked up last year. Being mindful of how hard it was to kind of see through the destocking containerboard, your level of confidence that the destock will be done in Q2? I'm just curious, have you started seeing any lift in China, starting to reopen here?
Mark Sutton (Chairman and CEO)
Phil, let me quarterback here. Clay is gonna take the question on the premium and the work we've done to change our go-to-market in fluff and our confidence in maintaining that. Then I'll ask Jay to comment on the containerboard. Actually, the question of supply chain really covers both businesses, maybe even more cellulose fibers in terms of getting things through the port and the velocity has improved. That does give better visibility. You asked specifically about containerboard in China. Jay will take that one. Clay, if you would answer
The question about,
Phil Ng (Managing Director)
Mark, my question on the supply chain was really more on fluff. I just made the point on containerboard because it was pretty hard to see through that. Just your confidence, kinda see through.
Mark Sutton (Chairman and CEO)
Okay.
Phil Ng (Managing Director)
the fluff side of things.
Mark Sutton (Chairman and CEO)
Sorry, Phil. Sorry, Phil, I misunderstood your question, Clay will take both of them.
Clay Ellis (SVP, Global Cellulose Fibers)
Hey, Phil, this is Clay Ellis. Good to talk to you. Your first point on market pulp, yeah, pricing on market pulp, paper-grade pulps, they were down in the Q1, somewhat resilient in Q1, and then in April, we've seen a huge decline, and you can see that in the publications through the month of April. Over, you know, over time, you can see the fluff pricing being resilient, keeping a pretty good high premium over market pulp. We expect that to continue. You know, I think when you look at the whole ecosystem of the fibers and the pulp, clearly going down through the Q1, and in paper grade, as we said on through April.
You know, fluff isn't immune to that, of course. Fluff prices have moved down some as well. I think, I think the fluff prices will continue to be less volatile. They'll continue to maintain a premium. To be realistic, in the whole ecosphere of the fibers, when they go down, there's a gravity on fluff, too. It's why it's more important for us to be, you know, higher integrated into fluff to have the capacity to grow with our customers' future growth in that space and, you know, remove or mitigate some of our susceptibility to the more paper grade or to the market commodity pulps.
Phil Ng (Managing Director)
You're confident of working through the supply chain and seeing through the destock?
Clay Ellis (SVP, Global Cellulose Fibers)
Yeah, very good confidence. Again, I mentioned on the call earlier last week with a lot of customers, the Geneva Conference, you know, even our customers, did not see the level of stocks. When I talk about stocks, it's not just fluff. It's through the entire absorbent hygiene supply chain. All the way from retailers, converters, our customers, and then all the way back into the raw materials like fluff. It was higher, more than anyone saw. So we see our customers are, they're seeing the retailers order more, get more normal, so they're seeing that slack has come out of the rope. We're seeing our inventories of fluff getting, you know, really down to historically, you know, lower than historical.
We see also part of this, I think, has been lowering the inventories across the supply chain to targets from where they were in the past. I think that's caused even, you know, prolonging this a bit more. Everybody sees more of the slack out of the system now, and they see it coming out and everyone's seeing their orders, no matter where they are in the supply chain, begin to pick up in moving into the H2.
Phil Ng (Managing Director)
Has that China reopening dynamic given you a little more confidence, or it hasn't really had much of an impact quite yet?
Clay Ellis (SVP, Global Cellulose Fibers)
Yeah, it gives us more confidence that, one, it's not a consumer demand issue, that it is destocking and that we can see the end. Yeah, that gives us confidence.
Phil Ng (Managing Director)
Okay, thanks a lot. Great, great color.
Operator (participant)
Thank you. I will now turn the call back over to Mark Sutton, Chairman and CEO, for closing comments.
Mark Sutton (Chairman and CEO)
Thank you, Leah. I'd like to thank everyone for your time today and for your continued interest in International Paper. I look forward to updating you on our progress as the year unfolds. Again, I would just like to thank our employees for the hard work through these challenging times, which really you can argue started a couple of years ago. They continue to show up every day, taking care of our customers, running safe and efficient plants, and selling and delivering products to our customers. I couldn't be prouder and happier to be leading this great team of people at International Paper. Thanks again for your interest in our company, and have a great day.
Operator (participant)
Once again, we'd like to thank you for your participating in today's International Paper's Q1 2023 earnings call. You may now disconnect.
