Good morning, everybody. Thanks for joining. My name is Goncalo Panjabi. I am the Packaging and Materials Analyst here at Baird on the equity research side. Welcome again to our 56th conference. This is my 18th.
Wow.
Just so you know, Andy. With us next, we have International Paper, and from International Paper, we have Andy Silvernail. Andy, this is your third conference together at International Paper with us.
I want to say it is my I came here the first time in 1994, believe it or not.
That is amazing.
As an analyst at Merrill.
Well, we appreciate your loyalty. Andy's been at International Paper as CEO since May of 2024, right?
Yeah.
Lots happened in the industry since then. We also have Lance in the audience, the CFO, and Mandy as well. Thanks again for joining. This is meant to be interactive. This is an uncovered company. I'm going to turn it over to Andy to give us a high-level overview of the company. We'll go from there.
Yeah. First of all, thank you for having me, and it's always good to be here. This is, in my opinion, the premier conference, one of two that really does a tremendous job around industrial. Thank you. Appreciate it.
Absolutely.
So, look, the last two and a half years have been a heck of a journey, right? With the fundamental turnaround of International Paper, the insanity of the external world in terms of tariffs and wars and inflation, and now the separation of IP from DS Smith, with DS Smith spinning out here, or selling at some point in the near future. That's a really important milestone. As I sit here today, when I joined in May of 2024, right, the level of the transformation required around International Paper was monumental. With this separation of the company, the really big things are done, right? The really big rocks that had to be moved, had to be changed, the fundamental things that had been in the way of International Paper succeeding, we will have changed the vast majority of those.
Then you move from there to, what do you become? Well, International Paper becomes the leader in sustainable packaging in North America by quite a bit. Our view is that it's a marketplace that is a good market, it's a good business. Structurally, it's a good business that's structurally getting better. It's structurally getting better over time. We've made the decisions around assets. We've made the decisions around business segments. We've made the decisions around structure and overhead, the things that should have been done for a very, very long time. Importantly, we've made the decisions around investment. So we've doubled the level of investment going back into the North American business over the last couple of years, and on fewer assets, right?
So we've doubled the amount of CapEx going back into the business to rebuild the productive capabilities of the business, and it's on fewer assets. So as you think about it as investment per unit of asset, it's changed radically over the last few years. Why does that matter? It matters because you started to see it in the third quarter. You started to see the inflection of profitability in terms of EBITDA margin spiking in the third quarter. We expect that to continue as we go into the fourth quarter. We've radically restructured the excess capacity that we held, right? So we've taken out about 20% of the total capacity of the business to be right-sized for the marketplace, and that's something that the company had hesitated to do over time.
Importantly, right, we have changed the commercial structure, and we have brought in some excellent fresh blood, including Lance, from the outside to infuse an industry that frankly had not seen a lot of people from the outside. It's an industry that had been very insular, and in that, I think comes pretty poor decision-making. So we have radically changed that and will continue to change that. So I'm excited for the future. I'm excited for what International Paper is becoming.
I'm excited for the structure of the business within the structure of the industry, and the promise in the future. That being said, lots of things, lots of headwinds, and lots of stormy things that are out there in the world that you got to deal with. One of the things that I love to do is I love to confront reality. Just tackle it, right? Tackle what is in front of you and go after it, and position your business to thrive within whatever world that we are in.
I think the world that we are in is going to continue to be tough. I do not see 2027, I do not see a miracle in 2027 in terms of economic change. We were talking a little bit in the hallway that maybe we are seeing a few things here and there at our customer base that are promising. I think we should expect 2027 to be a slog. I really do. I think it is going to be a slog in terms of demand, and I think we have a lot of headwind from inflation that is still rolling through the system. Our job is to overcome that, and I think we are well-positioned to do that as we go into 2027. With that, I will turn it to you.
Yeah. Lots of new energy at the company, including you.
Yeah, it is exciting.
and Lance. Same analyst covering your stock.
That's all right. That's good.
Couldn't resist. In terms of your journey at the company, obviously the macro is what it is, right?
Yeah.
It's widely telegraphed, and you're exposed to that to a big extent. But the company's also been through a lot.
Yeah.
When you joined, DS Smith was announced roughly around that time.
Yeah.
Now there's-
It was announced a little bit before I joined, yep.
Exactly. Now we're on the flip side of that where you're-
Yeah
looking at options for that.
Yeah.
So take us through the thought process as it relates to the strategy behind that.
Yeah. So, when I joined the company, and many of you have heard me say this many times, I was right there as that decision was being concluded. And so one of the things, the conversations that I had pretty forthright was, I reserve the right to change anything. Right? I spent about 16 weeks in Europe last year, hands on the ground. My wife and I moved, took our little dog, and we moved to Europe.
Oh.
We moved to Europe, spent a bunch of time in London, and then traveled throughout Europe, then a bunch of time in France, traveled throughout Europe. What became apparent as I dug in deeper and deeper and deeper is that while the business is a good business, while structurally DS Smith is a business that can succeed, if you think about two vectors of why companies are together, right? They are usually together around customer commonality and cost commonality, right? The more of the two of them, the more arguments you have for what I will call real synergy. On the surface, both of those arguments were true, right? On the surface, both of those arguments were true. You could argue that lots of global customers, and you could argue that there was a cost base that could be shared globally.
When you got into the fundamentals of how it really worked, that was not true. I remember sitting this time kind of last year, a little bit, maybe a month ago from this time last year, with my board going, "We need to separate this." Of course, you can imagine what the whole world said was, "Really?" My experience has been that once you have concluded something and you have real certainty around that, and we went and did a lot of deeper work around those hypotheses that I started to see early on. We did a lot of deeper work. But once you have made that conclusion, you should move. Time is not your friend. Time is no longer your friend once you have made those conclusions.
I would rather reposition both companies to win in their independent markets with unique balance sheets, unique investment capabilities, right? The structures of the markets are different. How competition happens is different. How customers buy is different. Let them go thrive. Let capital allocation move to where it should move. Let human resource allocation move to where it should move, and let the businesses thrive on their own. We made the decision in January of this year, and we have been moving fast. Lance has been leading the separation efforts, and he has done a phenomenal job around that, and we should conclude that relatively soon.
Okay. What would you say there's no, just from the sidelines, following the dynamics in the industry, there's no global procurement contracts?
Kind of.
Okay.
Here's what I say. There's what I would call theoretical interest in that. But when you get into the mechanics of how this business really works, even inside the U.S. to some degree, like we say we have a national account or we say we have an account, the primary relationship is actually a plant and a plant, right? We're servicing one of our customer's main plants. Some of our big customers who you know really well, they're going to have 10, 20, 30, 40, 50 plants that we're going to service with 10, 20, 30, 40, 50 plants. That's the primary relationship. That primary relationship is actually how things get built up into contracts. Contracts don't come like my office and I dream it up and I'm like, "Oh, let's have a national contract or a global contract." That's not how it works.
The plant in Tupelo, they have needs. They have a certain type of box with certain construction characteristics that they need that will roll up across our customer's 50 other plants, and that's what becomes a national contract. That's just nationally. Now there, you actually have integration across that customer. They will make a decision nationally. Once you get to global stuff, no.
Gotcha.
Actually, when you dug into it, you go, "Wait a second, this is actually bad for us." Right? Because there's this theoretical opportunity of more business, right? Okay, I've got $100 million of business in the U.S. and I got 20 in Europe and should be just as much. The two people making the buying decisions, they don't probably even know each other in the other company. I think, like many businesses, you fall into a fantasy of synergy versus how it really works at the fundamental level.
I get it. I cover companies like that.
Yeah.
Other ones as well. As you think about the structural differences in the market, Europe versus the U.S., what would you highlight there?
Yeah, a few things, and they're big things, right? Let's start with kind of customer concentration and how you think about the Not customer concentration, but rather customer decision-making and who the customer is. In Europe, it's a lot more fast-moving consumer goods, a lot more. So think of a lot more lightweight boxes, much, much faster innovation changeover, right? Because it's actually branding, right? It's fundamental branding. We have that in the U.S. too, but in Europe, if that's 70/30, in the U.S. it's 30/70. It's really different. The U.S. tends to have a much more logistics-heavy structural dynamic to it, right? Because we're moving things over much longer distances typically, right? Because of the infrastructure and the size and the territory and whatever. Also in Europe, there's a lot more shelf-ready product. In the U.S., it's happening, but it's happening very slowly.
Those combinations of things make the buying side really different, right? The, you know, what gets bought gets really different. U.S. more consolidated, Europe less consolidated. U.S. is much more virgin, right? Again, it is interesting, it is almost the same dynamic as the consumer versus because it is the lightweight aspects of it. So much more virgin in the U.S., less recycled and lightweight growing. Europe, a lot more recycled and a lot more lightweight, right? So they are really very, very different businesses. Because of the dynamic of lightweight versus heavyweight, of virgin versus recycled, how energy gets produced and consumed is also very different. In the U.S., we make about 70% of our own energy, and almost all the rest of the energy comes from natural gas, which is plentiful and it does not move very much.
In Europe, right, because you do not have the virgin process to recycle energy, recycle steam, you are buying energy on the markets and you are buying energy in natural gas, and we have all seen the volatility of natural gas, right? So they are really, really different markets. It does not mean that one is better than the other. It means they are really different in how they behave, and it means how you think about investment criteria, how you think about capital allocation decisions, how you think about people, how you think about innovation, how you think about design. Yes, they are both made from fiber. That is where it kind of ends.
Okay.
Yeah.
I will ask one more question on that, then I will open it up to the audience. In terms of the separation, is it sort of a, to use my words, dual track?
Yeah, that's a great way to put it. Yeah.
Okay. What is the timeline? Because going through a transition-
Yeah
shareholders have to endure the volatility of news flow and so on and so forth. When does it get cleaner?
Yeah. We laid it out when we first announced it, we said 12- 15 months. That was the timeline. That was the end of 1st of February, end of January last year. We have never stated anything different than that. You can read in based on what you've seen in the news and whatnot, you can read into that how you will. But certainly within that timeframe that we originally said.
Okay. So call it 1Q of next year, plus or minus.
At the very latest.
Yeah. Okay.
At the very latest.
Any questions in the audience? Okay, we will keep going. Let us switch to North America.
Yeah.
North America, I remember when you joined, you had a different view in terms of just given your background, your skillsets. With the 80/20 and permeating that in the organization. In initial conversation, one of the questions I asked you about the time it takes to permeate, right? Because you have a mature company and a mature industry, and it takes time to kind of get the message through and the metrics through and so on and so forth. Where are we on that?
We have made tremendous progress. When I think of 80/20, I think of it from the kind of very top level all the way down to the granular decisions that get made. What I would say is if you think of it from portfolio, right? Portfolio, geography, kind of really big buckets of decision-making, where do you want to be, where do you not want to be? We are vastly done with that. As I said, when the spin is done, those sorts of things will have been done. We have sold GCF.
We have exited a series of small businesses, product lines, and there are some little things left to do. But those are mostly done now and will be vastly done when DS Smith spins out. Then you start to move towards levels of decision-making around capacity and capital. Those are the big decisions of what we are not going to do are mostly done. There will always be things that go on, but big mill closures, obvious box plant consolidations, those things have mostly been done, right? We have taken out huge amounts of structural costs out of those things. And very importantly, we have stopped putting money into assets that really had no economic life.
We had some really big assets that had huge capital needs that were sucking from the system that we did not have the courage to shut down because I call it building a church for Easter Sunday, right? We got to have it because someday, dot, dot, dot. Well, you had to believe in something around the growth of the business and/or the ability to invest and change the quality of the assets to believe in those things. And so we made those really hard decisions. We took a huge amount of capacity out of the mill system.
And all of that capacity was either negative cash, right, or below its cost of capital through a cycle. So we basically took stuff out that was just a cash suck, right? Big cash suck that required. And we took those assets out of that investment, and we have moved all of it and more over into a new mill at NORPAC, right? Opening Waterloo. We have announced the Mississippi investment.
We have, God, I do not even know how many corrugators we have ordered. But one of the smartest moves we did was literally when we approved the strategy in North America in the fall of 2024, so two years ago, we did a massive pre-buy of equipment that is still layering into the system, which is really important because that is what is going to happen is you move down this funnel of big decisions to what I call aggressive continuous improvement.
That's where we're entering. That phase is where we're entering. So it still means there's lots of productivity to go get. There's lots of reinvestment back into the customer in terms of innovation, in terms of service levels, in terms of quality. There's lots of opportunity to still go there. But we're moving into that where you end up with a much more predictable business.
If I'm in your guys' shoes, and frankly for me too, one of the things that is enough to make you insane about this business is there's real volatility that you can't ever get away from, and then there's self-induced volatility. The real volatility in the North American packaging business is pretty modest. If you really think about demand over time, really demand over time, like even what we've been through the last two years with craziness of inflation and tariffs and all that insanity, is really only about a three-point band at the extremes, except for like in a crisis.
It's kind of a three-point band in the extremes. That's a pretty stable business that we have induced lots of volatility in. Poor investment into assets, so you get reliability problems. You get things that break that shouldn't break at times they shouldn't break. They get very expensive. You keep excess capacity, so you keep market volatility all the time. Just endless things. You buy businesses that are inherently much more cyclical. So the core, one of the things I love about the core North American business is it's actually pretty darn predictable from a volume standpoint. Now, price, I don't control. I control what I can do around price, but there's a market out there and the market decides what happens to that. So there will always be some volatility around that.
But one of the biggest mistakes that we made in the past is if you think about kind of cash flows as an upward sine curve in the marketplace, or could be an upward sine curve, us and most of the industry have chased the cash flows or matched cash flows and investment. So we spent money when we had money. Therefore, we spent money at the most expensive time to spend it. Right? It was volatile. What this business really requires is a steadiness of investment and a balance sheet with it that doesn't follow the sine curve.
That's really important in this business, because it's the only way you drive reliability, it's the only way you drive productivity, it's the only way you drive service levels consistently in the business. When you don't do that, everything goes like this. Assets out that are very volatile and not predictable, right? Investment in assets around a pretty stable volume business where we want to invest consistently year in and year out.
You're in an industry, in North America anyway, that has no shortage of data.
Yeah.
There's a lot of data out there. I think the industry took out about 10% of capacity last year in North America.
Yeah, that's about right. Yeah.
Including what you did as well.
Yeah.
The truest test is being able to translate that into some version of at least cost-related pricing, right?
Correct.
Because you think about this industry, the start of the year, one more black swan with the Iran war.
Right.
Oil spike, significant increase in cost inflation.
Yeah.
How did you handle through that?
There are a few things. One, all the work we had done before that wave of inflation spike has happened. Because we call it the Iran war, but it's really the building of the impact of global trade and the Iran war that is now moving its way through the system. If you look at the pricing that has happened in the market, really since I have joined the company, it is basically covered inflation.
That is effectively what has happened in the marketplace. There has been almost zero that has hit the bottom line incrementally. Our 40% increase since 2024 in EBITDA is 100% the cost we do not know, right? I would actually say it is more than 100% because actually price has been a little bit behind the inflation curve until about now. We are just starting to see it now. That inflation monster is going to be there.
If I just kind of look to next year as an example, and I think about, okay, so we are going to incrementally, we are going to take out between $250 million and $350 million of incremental cost next year. Right? That is what is going to come out of our And that is stuff that is already done, that is already lined up. Okay. You have got about $1 billion of incremental price, right, that you will see make its way through.
Carry over.
Call it somewhere between $900 million and $1.1 billion. The range is wider because it depends how it gets absorbed into the market and everything else, but a little bit wider range. So think of kind of 250- 350, and think of $900 million-$1.1 billion of cost out and price up. Then you go to inflation. Well, normally in our world, you'd look at about, call it $250 million of inflation, plus or minus that you kind of year in, year out see. It's going to be more than double next year. If you just take the strip, it's going to be more than double. So if you kind of put all cost headwinds that we see, you see about $600 million of cost headwinds in there. We expect that. I do expect it to moderate over time.
But the good news here on this is the cost-out engine is cranking. That is moving. While I believe the inflation headwinds will be there for some time, I do not believe we are going to see $600 million a year. I do not think that is going to. Five years from now, I do not think we are going to be sitting here going, "Boy, you had $600 million of inflation." I do not think so. Could be wrong.
Yeah.
But I do not think so. Importantly, the price that we have gotten, even the price that we are getting today, is supply-side driven pricing. It is inflation-driven pricing that is moving everything in the marketplace. Any movement in demand is going to be a net really positive thing. Look, we are very tight. We are running very tight. We will run very tight into the fourth quarter and throughout next year. We are kind of looking at that reality of the tightness in the paper markets. With some demand, I think it is a pretty attractive scenario.
The bridge for next year versus this year, you have self-improvement.
Yep.
You just kind of went through that.
Yep.
You have price cost. Went through that as well.
Yep.
What about stranded costs from the separation?
I mean
Material?
We'll take out most of it.
Okay.
Lance, the total, it gets left at 30-ish million. Is that about right?
Okay. So it's pretty minimal.
It is pretty minimal.
Okay
That will show up as kind of a classic. Even that will whittle down over time, but it is things like systems that you cannot. I mean, we have restructured IT, as most of you know. We have outsourced a big segment of our IT. We have already done that. Then there are things kind of within systems that require work to be done before you can just take the cost out.
Okay.
You have got 30-ish million or so, which will be out by 2028. Yeah, be out by 2028.
Okay, just kind of step back, Andy. If the industry had not taken out the capacity to the extent it did last year, call it 10%, would you have been able to get the pricing through as an industry this year?
It's hard to say, right? It's hard to judge that.
Okay.
The pricing conversation is always a dangerous conversation.
Yeah.
We stay super focused on what we can control and what we do, and that is really around how we interact with our customers and the value that they see.
Okay. This year, in terms of volumes, you had some issues with ag?
Yeah. We all did.
Yeah. I do not know how to say it. Cyclo something, right?
I won't say what I say in private. Lance is like, "Don't say it.
How did it progress, just from your point of view?
Look, it's interesting, right? You had a few things happen that were really fast bursts and we all were in the news and we all joked about it and laughed about it, but believe me, it was nothing to laugh or joke about.
Material.
It was a big deal. What you end up having is you end up having, for a period of time, people stop eating lettuce. Right? They just stopped eating bagged lettuce. That's kind of reversed now. That's making its way through now. That consumer demand is coming back. But remember, it waits until the next planting season. You got to get to now, you got to get to the next planting season. You kind of end up with a lull. But what I would say is, as you go through the fourth quarter, it appears most of that is through the marketplace. But in terms of it picking back up and getting back on what I'll call trend, it'll be in the planting season.
The El Niño year.
Yeah
that is widely discussed.
Yeah.
Historically, how has that impacted you?
Man, do you have a point? I don't really have a point of view of that. I don't know that we have-
It's lots of rain.
Yeah, it's lots of rain, but I Look, to some degree, when you're doing business with God
Yeah
you just got to kind of deal with it and
Upside.
you just do it.
The free cash flow, the guidance this year, call it two, three plus or minus on EBITDA, right?
Yeah.
The free cash flow, if I have this right, $100 million-$200 million?
Yep.
Why is it so low in terms of conversion?
Investment.
Yeah.
We are just investing back into the business in a huge way. In the last quarter, a little bit of working capital catch-up, right? We had a really heavy downtime in the second quarter, so you had some working capital catch-up going in there. As I look to the future of free cash flow, I like that, right? It is a good dynamic. Even with an elevated investment, we are going to be in that kind of $1.25 billion-$1.4 billion. CapEx range for the next couple years. We will be in and around that range. Then we will more normalize to about 7.5% of sales as you get
Okay
a little bit further out. When I think about the cash flow dynamics as we look into the out years on the North American business, this is a good free cash flow business.
Okay. All right. As it relates to post everything you have going on, the separation and so on, what happens to capital allocation? How should we think about that?
First things, I think we are as long as I am CEO, we are never going to make the mistakes that we made the past 15 years.
Okay.
When you actually track back, if you look back and you say, "Where did the wheels start coming off of International Paper? You actually can track it back to about 15 years ago, and two things happened, right? So kind of think of post the Great Recession.
Post this, yep.
First Great Recession. We stopped investing aggressively back into the core business, and capital allocation started moving to things that when you track them back today, you go, "Can't find that money," right? It wasn't going back into our facilities. In a business like ours, it's kind of like your car. You buy a new car. You can get away with it for a little while. You can not change your oil the first time, maybe even the second time, and then it starts to catch you. You actually saw it, you saw the separation happen about three years later, where OpEx started going up.
Right? CapEx was going down, but OpEx was going up. Then, it's a net benefit for you for a period of time, and then the lines crossed. The net cost of the two actually turned negative compared to where they should be. That started happening in kind of the late teens. At the same time as kind of you had world synchronized growth. Everything looked great, right? You had kind of two, three years where everything looked great, and then COVID happened.
When COVID happened, there was massive demand on the system. When we all went home and we were all ordering stuff to come to our houses, massive demand went on the system, and that showed the underinvestment in IP. What happened was, you saw it, we went from being consistently in the kind of number one or number two in customer satisfaction. By 2022, we were dead last of the majors.
We are now back to being number one, and that is all tied to the investment dearth that started in 2010-ish, 2011. Why does that all matter? It matters because you can never do that again. You have to invest in this business year in and year out. For the quality of this business, you have to do it. And the competitive advantage is those who have inferior assets, especially when capital costs go up, and especially when asset costs go up. To build a box plant or a mill is somewhere between 50% and 75% more expensive than it was in 2020. It is amazing. If you do replacement cost economics on our business it's eye-popping, right?
Why does that matter? It means you can't let the assets die. You have to invest year in, year out. By the way, those who don't invest and/or those who have inferior assets, the separation of quality is going to grow over time. That's number one. Number two, we need a dividend, right, that our investors look at and go, "That is reliable," right? "That's not going to move. It's going to be consistent." What we've said is post-spin, somewhere in the 40%-50% of free cash flow. That's what we've said consistently. We'll make that ultimate decision when the separation happens, but you can kind of do your math and you can get a sense of what that means. The next one is around acquisitions and/or buybacks, right? What I would say is around acquisitions, what you should expect from us is small ball.
You should expect to see us buy very consistently, buy small assets in terms of converting facilities. There aren't many mills that are for sale, but if you had a high-quality one, like we did NORPAC, we would do that. But you're talking about $100 million-$1 billion. You're not talking about things There's a couple of assets out there you go that are multi-billion, but not even five, right? That you go, "I like those." The other choice is around buybacks, right? Which, for those of you who have known me over time, I'm a big fan, right? I'm a big fan of buybacks at the right time when done well. You put that capital allocation model, and then you always have to be willing to build cash.
Yeah.
Anyway, I think capital allocation is going to be a massive piece of the story over time. I think the discipline, for those of you who have known me when I was at IDEX, that was a huge piece of our success over time. You should expect that same discipline.
At your time, thank you again for your loyalty.
Thank you very much. Thank you, everybody. Appreciate it.
Thanks for everyone for joining. The next presenter will be Mueller Water Products. Thank you.
Great to see you. Thank you very much.