Sylvamo - Q3 2023

Transcript

Operator (participant)

Good morning, and thank you for standing by. Welcome to Sylvamo's third quarter 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, you will have an opportunity to ask questions. To ask a question, please press one then zero on your telephone keypad. To withdraw a question, please press one then zero again. As a reminder, your conference is being recorded. I would now like to turn the call over to Hans Bjorkman, Vice President, Investor Relations. Sir, the floor is yours.

Hans Bjorkman (VP of Investor Relations)

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 two and three 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.

Jean-Michel Ribiéras (Chairman and CEO)

Thanks, Hans. Good morning, and thank you for joining our call. Let's turn to slide four, please. In the third quarter, we achieved $158 million in adjusted EBITDA and generated strong free cash flow of $150 million-- $155 million, sorry. 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 expectation, reflecting ongoing China inventory restocking and weaker than expected demand. We strengthened our financial position in the third quarter with net debt now at $796 million and at a 1.2x net debt to adjusted EBITDA ratio.

We also deposited $60 million in escrow to remove cash return limits related to the Brazil tax dispute in our credit agreement, while returning $24 million in cash to shareholders in the quarter. Slide five 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 administrative cost reduction, shrinking working capital, and adjusting the timing of capital spending. I'm proud of how 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?

John Sims (SVP and CFO)

Thank you, Jean-Michel. Good morning, everyone, and thanks for joining our call. Slide six shows our third quarter earnings results. As Jean-Michel stated, we earned $158 million of adjusted EBITDA in the quarter, which was slightly higher than our guidance of $130 million-$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 outages 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 seven. This slide shows 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? You know, 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 onto 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 eight. 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. On this slide, you can see North American comparisons for 2021, 2022, and the first half of 2023. 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 nine.

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 resilience. 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-$110 million. We project price and mix to decrease at a slower rate of $20 million-$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-$25 million. This will reflect seasonally stronger volume in Latin America, the completion of destocking in Europe and North America, as well as the new business we picked up in North America.

Operations and other costs are projected to increase by $25 million-$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-$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-$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-$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 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 in mature demand, cyclical markets. 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 2/3 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 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. Through 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 could return more than $90 million. Our board of directors increased our regular dividend by 20% and declared a 30-cent 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. So, Michel, I'll turn it back to you.

Jean-Michel Ribiéras (Chairman and CEO)

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 shareholders' value by managing what we can control. First, we have allocated cash to improve our financial position by reducing debt by 35% or $530 million to strengthen our balance sheet. Second, we continue to deliver on our investment thesis. We have earned over $1.2 billion in Adjusted EBITDA, which is a 19% margin. We also generated $568 million in free cash flow and returned $200 million to share owners since our spin-off. 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 partnership. Operational excellence remains key to our performance as we leverage our low-cost assets and resilient forest assets. John walked you through our cost reduction initiative, Project Horizon, which will make us a leaner, stronger company. We understand that all our efforts to reduce our global salary positions may affect our colleagues whose position will be eliminated. We will help these employees by providing transition service and want to thank them for their service.

Financial discipline is extremely important to us. We will continue to leverage our strengths 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, so our talented team, iconic brands, and low-cost mills in favorable location, with confidence in our future and motivated by the opportunities that lie ahead. With that, I'll turn the call back to Hans.

Hans Bjorkman (VP of Investor Relations)

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

Operator (participant)

Okay, ladies and gentlemen, if you'd like to ask a question, please press one then zero on your telephone keypad. You may withdraw your question at any time by repeating the one zero command. If you're using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, please press one then zero at this time. And one moment, please, for your first question. Your first question comes from the line of George Staphos from Bank of America. Please go ahead.

George Staphos (Managing Director)

Thanks very much. Hi, everyone. Good morning. Thanks for the details. Hey, the first question I wanted to hit on is with, you know, 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 2024, recognizing, obviously, you know, it affects a number of people who worked with the organization for a long time, and it is bittersweet, but what do you think the net benefit to the P&L would be from this program in 2024?

John Sims (SVP and CFO)

George, good morning. It's John.

George Staphos (Managing Director)

Okay.

John Sims (SVP and CFO)

To answer your question, you know, we're targeting $110 million run rate by the end of 2024.

George Staphos (Managing Director)

Right.

John Sims (SVP and CFO)

We do have on the slide, we're estimating that inflation for 2024 is going to be approximately $50 million. So the net benefit in total will be $60 million. Yeah, once we get to the full run rate. In 2024, we're expecting a net benefit about $10 million-$15 million.

George Staphos (Managing Director)

Okay. Thanks for that, John. Second question, you know, what we've been seeing in volumes, while maybe from an amplitude standpoint, is larger and therefore worse than expected, it's not unreasonable based on history. It's fairly consistent with seeing big drops in demand, you know, in very large economic downturns or decelerations. You know, whether or not we're in a recession, certainly from the companies that I look at over the last year or so, the volumes have been such where I think packaging paper has been basically in a recession. And what you normally then see, though, is not a real rebound in demand. Rather, the world learns to be more productive, and you have a new demand level for uncoated freesheet.

What do you think in terms of where we are right now, in terms of any further demand destruction that we may see or may not? Hopefully, it's, it's resolved. And what if you had to estimate at this juncture, what do you think your shipments, your demand will look like in 2024 by market, year-over-year, if you can provide that?

Jean-Michel Ribiéras (Chairman and CEO)

Hi, George. Jean-Michel. Thanks for joining the call. I think, as you say, we've had in our cycles some, more strong numbers, sometimes in decrease, due to economical factors, due to COVID, due to multiple, factors. Even if you take 2023, a strong decrease. We are still in our trend back to, four to six percent in the U.S. downtime and back to three to four percent down in Europe. I think we are, 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 the inventory correction you've seen this year, you could kind of think, is it much worse than this trend? And numbers show it's not. 2024, it's difficult to predict. What we do know in 2024 is we do not expect to have the inventory correction again.

When you compare it to 2023, it should probably look better, but on the trend, demand, gee, I think there is no change. It's still a -5% globally.

George Staphos (Managing Director)

Yeah. Jean-Michel, there was only two- Sorry, go ahead, John.

John Sims (SVP and CFO)

Yeah, I was just gonna add one more comment to that is that, you know, this is—I think we agree with what you're saying, and to the extent for North America and Europe. Latin America, the demand is down, but most of that is all due to inventory correction. So, you know, I just must focus that, you know, for one part of our market, we're not seeing that recessionary-type decline that you referenced.

George Staphos (Managing Director)

So should we expect on a year-on-year basis that demand should match consumption in 2024? Or would you expect some inventory rebuild such that you might actually see some year-on-year increases in percentages for the grades? And my last one, I'll turn it over. Can you talk about the, you indicated you had a new win in North America, if I heard you correctly. If you could talk to that, that'd be great, and I'll be back in queue.

Jean-Michel Ribiéras (Chairman and CEO)

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

George Staphos (Managing Director)

Thank you. I'll turn it over.

Operator (participant)

Your next question comes from the line of Matthew McKellar from RBC Capital Markets. Please go ahead.

Matthew McKellar (VP)

Good morning, and thanks for taking my questions. Maybe just picking back up with Project Horizon, is there any more color you can give on, you know, what kind of opportunities you're seeing to reduce costs on the manufacturing supply chain side in particular, including if there are any specific mills or even geographies that you call out as presenting the best opportunities? And then, is there a need to spend capital to achieve some of these savings?

John Sims (SVP and CFO)

Yeah, Matt, on a couple of, first of all, some of it is realization of capital that was already spent in terms of cost reduction. And then we also do have some cost reduction capital plan for next year that will yield some benefit. The other areas is that, you know, it's just continuing to work on efficiencies around energy consumption, chemical consumptions, and becoming, you know, more efficient in terms of our operations.

Jean-Michel Ribiéras (Chairman and CEO)

I'll add to that. We have some probably a little bit more opportunities in supply chain, especially in North America. When we spin, we kept the network we had before, mostly intact. We didn't look at what was the opportunities to, ameliorate, optimize that network. Now that we have two years of experience and understand better the market and where we do, 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 fall, supply chain, but there are good opportunities there too.

Matthew McKellar (VP)

Great. That's helpful. Thanks for that. Maybe next, it sounds like you're expecting channel inventory corrections to be largely complete by your end. Would that be the same or similar across geographies? Are there any areas where you'd call out as being a little bit different as you look from region to region? And in particular here, I'm thinking about Latin America, which I think you've said has kind of exhibited different demand trends and would be seasonally stronger in Q4.

Jean-Michel Ribiéras (Chairman and CEO)

Yeah, I think, Latin America, the strongest we saw was, not Brazil, other Latin America. And I would 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 other intakes and what our customers said, that give us good indication that inventory correction is done.

Matthew McKellar (VP)

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

Jean-Michel Ribiéras (Chairman and CEO)

Thank you.

Operator (participant)

Next, we'll go back to the line of George Staphos from Bank of America. Please go ahead.

George Staphos (Managing Director)

Thanks so much. So I want to come back. I think Matthew, you know, cued it up nicely on Project Horizon. So was this a program that you developed internally, either from, you know, existing learnings you had within Sylvamo or, you know, 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 you know, again, we've got supply chain, we have 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, you know, keep in mind and give us more or less optimism on its prospects?

John Sims (SVP and CFO)

Well, there's two things on that, George. First of all, you know, we named it Project Horizon because this was a project that it talked 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 spend behind us. And so we did this internally. This is about focusing on focusing on our strategy and make 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.

And some of this has to do with us continuing to, you know, ramp up our investments that we've been doing and showing in terms of our facilities, both in the maintenance and the cost reduction capital. But it's also more of a concerted effort and focus on areas of opportunities we have to improve our operations. We set a short timeframe 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-$15 million in 2024, but this is gonna be an exit rate, so you should be seeing it, you know, beginning first quarter of 2025.

Jean-Michel Ribiéras (Chairman and CEO)

If I may, John, I would just add, just in supply chain, when I was talking about network optimization, we did get some specialist of supply chain services to help us, and we're continuing to have them, helping us with designing our network and thinking about it different.

George Staphos (Managing Director)

Okay. But I actually just wanna make sure I understood. So the $10-$15, I took that as a net realized with the run rate being, you know, 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, you know, $30 million-$40 million benefit you get in 2025 based on the program?

John Sims (SVP and CFO)

That's right. The net benefit is $10-$15 after inflation, and the $60 million is net of inflation.

George Staphos (Managing Director)

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

John Sims (SVP and CFO)

Yeah, that's probably a good way to describe it. It was a bottoms-up work with an extensive, let's say, you know, extensive feedback or information from everybody working in our facilities.

George Staphos (Managing Director)

Okay.

Jean-Michel Ribiéras (Chairman and CEO)

Some of it is due also to our cost investment that John mentioned. We've invested in some equipment, in some mills, in much better online data analytics to get the capacity now to much better understand clients and predicting them and act on them. Some of the cost programs we've done with this observation, 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.

John Sims (SVP and CFO)

George, let me add, you know, these are structural changes, so these are not. We're not trying to push off or avoid. When we're looking at $110 million, these are sustainable changes. So they do not include, for example, increased volume and absorbing, you know, unabsorbed fixed costs that we had this year versus because of the lack of ordered downtime we took because of the inventory correction. So that's not included in this $110 million.

George Staphos (Managing Director)

No, interesting, John. One last quick for me, and then I'll turn it back and try to get back in queue. I remember discussion about Latam seeing some improvement in volumes with the textbook program. Did that materialize, and how's the order book in Latam going into 2024? Thank you, guys.

Jean-Michel Ribiéras (Chairman and CEO)

Yeah, it did materialize mostly, and order book is good. You know, it's a seasonality also, which is always very good on the fourth quarter. So fourth quarter in Latam is the strongest one, first quarter is the weakest one, but that's just the season of demand.

George Staphos (Managing Director)

Thank you.

Operator (participant)

Mr. Staphos, please continue with your questions. Mr. Staphos, your line is open. Please go ahead.

George Staphos (Managing Director)

Oh, thank you so much. Last ones from me. So, share repurchase—currently available authorization—did you say $160 million? And do you have an outlook on maintenance at this juncture, gentlemen, for 2024? Thanks, and good luck in the quarter.

John Sims (SVP and CFO)

Yeah, we have, I think it's, I believe, $167 million, that's our authorization. We have yet to. We're still developing the plan for 2024, and we'll probably be sharing the maintenance outlook with you in- when we announce the fourth quarter.

George Staphos (Managing Director)

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

John Sims (SVP and CFO)

I would say right now, relatively flat.

George Staphos (Managing Director)

Okay. Thank you, John.

Jean-Michel Ribiéras (Chairman and CEO)

For me?

George Staphos (Managing Director)

Yep, understood. Thank you, guys.

John Sims (SVP and CFO)

Thank you, George.

Operator (participant)

And at this time, there are no further questions. I'd now like to turn the call back to Hans Bjorkman.

Hans Bjorkman (VP of Investor Relations)

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

Jean-Michel Ribiéras (Chairman and CEO)

So first of all, thank you for joining our call. We remain a cash flow story. We're projecting more than $230 million in free cash flows this year, and we remain committed to returning $125 million to shareholders. We remain confident in our ability to generate stronger, big time 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're confident in the future. So thank you, everybody.

Hans Bjorkman (VP of Investor Relations)

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.

Operator (participant)

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.