Edited Transcript of WRK.N earnings conference call or presentation 5-May-20 12:30pm GMT

May 6, 2020 (Thomson StreetEvents) — Edited Transcript of Westrock Co earnings conference call or presentation Tuesday, May 5, 2020 at 12:30:00pm GMT

Ladies and gentlemen, thank you for standing by, and welcome to the WestRock Company’s Second Quarter Fiscal 2020 Results Conference Call. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Mr. James Armstrong, VP of Investor Relations. Thank you. Please go ahead.

Thank you, operator. Good morning, and thank you for joining our Fiscal Second Quarter 2020 Earnings Call. We issued our press release this morning and posted the accompanying slide presentation to the Investor Relations section of our website. They can be accessed at ir.westrock.com or via link on the application you are using to view this webcast.

With me on today’s call are WestRock’s Chief Executive Officer, Steve Voorhees; our Chief Financial Officer, Ward Dickson; our Chief Commercial Officer and President of Corrugated Packaging, Jeff Chalovich; as well as our Chief Innovation Officer and President of Consumer Packaging, Pat Lindner. Following our prepared comments, we will open up the call for a question-and-answer session.

During the course of today’s call, we will be making forward-looking statements involving our plans, expectations, estimates and beliefs related to future events. These statements may involve a number of risks and uncertainties that could cause actual results to differ materially from those we discussed during the call. We describe these risks and uncertainties in our filings with the SEC, including our 10-K for the fiscal year ended September 30, 2019.

In addition, we will be making forward-looking statements about the impact of COVID-19 pandemic on our operational and financial performance. The extent of these effects, including the duration, scope and severity of the pandemic, is highly uncertain and cannot be predicted with confidence at this time. We will also be referencing non-GAAP financial measures during the call. We have provided a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures in the appendix of the slide presentation. As mentioned previously, the slide presentation is available on our website.

Okay. Thanks, James. Thanks to those of you who have dialed in to join our call this morning. We have a lot to cover.

I’ll start by thanking the amazing WestRock team for all they’re doing to help connect essential products to people around the world. The WestRock team, supported by the scale and broad capabilities of our mill and converting network have responded heroically to help our customers meet the changing market conditions caused by the pandemic.

We generated solid financial results in the quarter, with adjusted segment EBITDA of $708 million. This was on the high-end of the guidance that we provided last quarter. We’re executing our differentiated strategy from a position of financial strength and substantial liquidity.

The COVID-19 pandemic has impacted global markets, caused unprecedented volatility and clouded the economic outlook. Against this backdrop and thanks to the performance of the WestRock team, the company has continued to deliver as an essential part of the global supply chain, supporting our customers with a portfolio of products and solutions and global reach that they need to get their products to the consumers who need them.

The pandemic has disrupted demand patterns across our business, and while some markets, notably, e-commerce, have been very strong, others, including industrial markets, have seen significant negative impacts. We continue to believe that our long-term drivers of growth remain unchanged, that WestRock remains well positioned with the right strategy to succeed and create value for all of our stakeholders.

Having said that, the global economic outlook has softened significantly in the near term. We’re, therefore, implementing an action plan through which we’re taking prudent and appropriate steps to prepare for a range of economic and market conditions. We’re focused on meeting the needs of our customers, supporting the health, safety and well-being of our teammates and further building on our foundation of financial strength.

Following are the key components of our pandemic action plan. We’ve standardized enhanced safety measures across our company, including social distancing, deep cleaning, face coverings, temperature checking and other practices to help keep our teammates safe and healthy. Our team has done incredibly well through this time. And during this quarter, we’ll provide onetime recognition awards to our manufacturing and operations teammates.

We’ll continue to match our supply with customer demand, including reducing shifts at plants where necessary and taking downtime at our paper machines that serve markets with reduced demand. At the same time, we’ll take advantage of opportunities where they present themselves, including using the scale and capabilities of our existing system to serve growing markets, including e-commerce and responding to surges in demand.

We’re implementing near-term operating cost reductions led by salary and retainer decreases of up to 25% for our senior executive team and our Board of Directors as well as reductions of discretionary expenses. We plan to use our company’s stock to pay our annual incentives and make our company-funded 401(k) contributions in 2020. This will provide additional cash available for debt reduction while further aligning the incentives of the management team and teammates at all levels of the company with our investors.

We’re reducing our capital investments by $150 million this year and will invest $600 million to $800 million in fiscal 2021. At this level, we’ll complete the strategic capital projects we have underway, maintain our system and make the capital investments necessary to improve productivity and supply our growing markets.

And finally, we’re resetting our quarterly dividend to $0.20 per share for an annual rate of $0.80 per share. This is a prudent step to take in an uncertain environment that will provide meaningful, sustainable and competitive dividends for WestRock’s stockholders while allocating an additional $275 million per year to debt reduction. This will benefit our stockholders by reducing leverage, enhancing liquidity and sustaining our access to long-term debt capital markets.

As the situation with COVID-19 evolves, we will reevaluate our dividend and look to grow our dividend in the future as markets return to normal. This combination of actions will enable us to adapt quickly to changes in market conditions, and we expect will provide an additional $1 billion in cash available for debt reduction through the end of fiscal ’21. This will sustain our business under a range of economic and market conditions and ensure that WestRock remains well positioned for long-term success.

WestRock’s response to the pandemic to date and our ability to succeed going forward hinges on the hard work and dedication of the WestRock team, which has stepped up to keep our operations running and to help our customers. We’ll continue to support our teammates, their families and the communities where we operate. While the near-term outlook is unclear, we have the right strategy and the right team in place to navigate this environment and to emerge an even stronger company.

In addition to the standardized and enhanced safety procedures we’ve implemented across our company, we’re now working quite differently than we were just 2 months ago. Whether we’re working in an operating facility or at home, we’re meeting more frequently than ever to identify and address the rapidly changing operational issues as they arise. This is supporting our efforts to adapt quickly to meet the changing needs of our customers.

And we’ve stepped up for our communities, including partnering with our customers and also the Georgia Center for Medical Innovation to provide manufacturing support for more than 200,000 face shields. We’re donating corrugated boxes and food service containers to food banks, and also for charitable food distribution in many of our communities.

Let’s turn to our performance for the second fiscal quarter. We generated net sales of $4.4 billion with adjusted segment EBITDA of $708 million, adjusted earnings per share of $0.67. Over the past year, we’ve advanced our differentiated strategy with strong growth by adding 380 additional machine replacements. We’ve added 20 enterprise customers over the past 12 months. Enterprise customers now make up $7.5 billion in sales compared to $6 billion a year ago, a 25% increase.

Overall, we have substantial financial flexibility with more than $2.5 billion of long-term committed liquidity, including more than $600 million of cash. We have limited debt maturities until March of 2022, and our U.S. qualified pension plan is 102% funded.

During the quarter, we experienced strength in e-commerce channels and in the protein, processed food, agriculture, health care and beverage market segments. Other market segments, including luxury goods and industrial products, softened as a result of the impact of COVID-19.

Our second quarter results reflect higher export and domestic containerboard volumes and box shipments. The price/mix variance reflects the flow-through of previously published price decreases and the year-over-year market declines in export and domestic containerboard, pulp and kraft paper pricing.

Corrugated Packaging delivered solid results in the quarter, with adjusted segment EBITDA of $502 million and adjusted segment EBITDA margins of 18%. North American adjusted EBITDA margins were 19%, and Brazil’s adjusted EBITDA margins were 28%.

During the quarter, strong operational performance with higher volumes, strong productivity and deflation were more than offset by the pricing declines. Strong sales in e-commerce, processed foods and retail products like cleaning products, paper products and diapers were offset in the second half of March by significant reductions in our end-use segments of distribution and paper, industrial products and foodservice and Pizza packaging.

This trend has continued into April, with more than 130 of our customers reporting temporary plant closures. That’s 130 of our customers reporting temporary plant closures and reduced shifts based on the effects of the coronavirus. Even segments like protein and processed foods are suffering downtime due to the effects of the coronavirus on their employees.

Box shipments during the quarter increased 1.3% on an absolute basis, with shipments increasing at the end of the quarter as consumers began sheltering at home. Our box shipments were negatively impacted by the closure of 5 box plants over the last year as well as reduced demand from industrial, distribution and pizza market segments, and lower sales of low-margin sheets to third-party converters. The cumulative impact of these factors reduced our box sales by 2.7% compared to last year.

But let’s put this in perspective. Over the past 3 years, we’ve been very successful at growing our box business. In fact, our box shipment organic growth over this time is approximately 10%, nearly twice the industry growth of 5.5%. Our commercial approach to our customers continues to work well to meet rapidly changing customer needs.

The strength of our preprint business has enabled us to open a new location in Las Vegas to meet our growing demand for graphics and to supply our expanded footprint with the addition of the KapStone system. We’re expanding our Jacksonville preprint facility to add a continuous run press will provide incremental capacity and reduce cost.

Our domestic and export containerboard sales increased a combined 112,000 tons in the quarter compared to last year. 30,000 tons of the increase came from our higher-value white top liners. Our strategic projects and integration of KapStone continue. We ended the quarter with an annual run rate of $125 million in synergies from KapStone. Our team has made substantial progress reconfiguring the North Charleston mill following the permanent shutdown of the #2 paper machine. The mill’s specialty grade mix has been redistributed across the remaining operations, which has optimized our manufacturing and provided cost efficiencies. We anticipate being at our planned production rates and savings by the end of the calendar year.

In sum, WestRock’s corrugated packaging team is executing extremely well in this environment, supported by our well invested box plant system and our mill system with outstanding geographic coverage and the capabilities to make the widest range of containerboard and kraft paper grades in the industry.

Let’s turn to our Consumer Packaging segment, where results were roughly flat year-over-year with adjusted segment EBITDA of $222 million in a highly volatile environment. In the quarter, our food, food service, beverage and health care businesses performed well on higher price mix and benefits from plastic replacement initiatives.

Our differentiated value proposition that leverages design, material science and machinery continues to deliver value for our customers. This upside was offset by reduced demand in beauty, cosmetics and high-end spirits. Lower commercial print demand in March contributed to our taking 13,000 tons of economic downtime in the quarter and another 14,000 tons in April across our SBS system. CRB and CNK backlogs remained solid at 3 and 5 weeks, respectively.

Consumer Packaging participates across a wide range of end markets. We view the business through the lens of 4 key categories: First, the food, food service and beverage businesses comprise about 57% of our segment sales. We win with our customers with our differentiated, integrated folding carton offerings and our full range of paperboard substrate sales to independent converters. These businesses deliver growth and value through innovation, differentiated products, machinery and customer service; second, our specialty packaging businesses account for about 28% of our segment sales. Our value-added in specialty packaging is weighted toward the converting side of the business. The health care business has been very strong and is supported by our integrated offering of cartons, labels and inserts. While the performance of our other specialty offerings for consumer goods, payment cards and media have been mixed, some growing, some declining over time; the third category is specialty SBS paperboard for tobacco, commercial print and liquid packaging. This accounts for about 13% of our segment sales. This category has been challenged in the recent years due to secular volume decline in commercial print and tobacco, which to provide context, have declined more than 20% since fiscal ’16; fourth, we use pulp to balance our system. Recent pulp price declines have lowered earnings by approximately $28 million year-to-date and $12 million in the quarter as compared to last year.

We’re seeing good opportunities to grow using our material science, innovation, machinery offerings and commercial approach with our customers. We’ve invested in our converting assets, and we’ve invested in our mill system at Mahrt, Covington and Demopolis to improve our cost structure and product quality. At Covington, we’re now producing the lowest density SBS in the world for folding carton and other applications.

So while many parts of our Consumer Packaging business have been improving and are well positioned to continue improving over the long-term, these improvements have been offset by the performance of our lower value-added and declining end market segments. We continue to be committed to improving the long-term performance of this business.

WestRock is well positioned to weather the current economic environment. We have the ability to serve a wide array of end market segments, we have flexibility across our supply chain, including the ability to use both virgin and recycled fiber. Our global scale provides redundancy and versatility in this rapidly changing market.

End market demand is quickly changing. Slide 11 provides an overview of current conditions in our markets. As noted earlier, demand in e-commerce channels is very strong. We believe this will continue to grow. Processed and retail food markets, beverage and liquid packaging were strong in March as customers sheltered in place and worked from home.

Protein markets have shifted from strongly positive to negative over the last few weeks as protein processing companies have felt the impact from COVID-19. Industrial and distribution customers demand has been negatively impacted by closures, and other markets such as food service and commercial print continue their pattern of end market declines from the previous quarter.

From where we stand today, it’s difficult to predict which trends are transient, and which will persist. Fortunately, our diverse portfolio of paper and packaging products positions us well to adapt and meet our customers’ changing needs across a broad cross-section of the economy. While the outlook remains unclear, we have taken and are preparing to take actions to navigate market conditions as they develop.

Thank you, Steve. In addition to our ability to generate cash from our business, active management of our debt maturities and maintaining significant levels of liquidity are core elements of WestRock’s strong financial foundation. In fiscal 2019, we extended the maturities of more than $3 billion of committed credit facilities and more than $2 billion in bank term loans.

In addition, last year, we refinanced $350 million in bonds that were due in March of 2020. We have limited bond maturities until March of 2022, with only $100 million that is due in June of this year. At the end of March, we had more than $2.5 billion of committed long-term liquidity, including $640 million in cash. Traditionally, we generate stronger cash flows in the second half of our fiscal year. As we closed out April, we were able to reduce net debt by approximately $145 million. With this debt reduction in April, our committed — our current committed liquidity and cash is approximately $2.7 billion.

We have abundant cushion on our 2 debt covenants, and this provides us with significant flexibility to run our business. In addition to actively managing our debt maturities and liquidity, our pension plans are in a strong position. As Steve mentioned, our U.S. qualified pension plan is overfunded, and our global cash contributions to our qualified plans in fiscal 2020 is only $10 million.

Moving to Slide 13. We are withdrawing our full year guidance due to the challenging economic environment associated with COVID 19. Although we are not providing guidance for Q3, recent trends are likely to cause sales and earnings to decline sequentially. Steve highlighted the changing demand trends across many of our end markets, which are negatively impacting volumes in specific segments of our business.

In addition to an uncertain volume outlook, Q3 results will reflect the flow-through of the published index reduction for linerboard in January and the February reductions for SBS and recycled boxboard grades. And although some input costs are declining, recycled fiber costs are up more than $50 per ton since December. As conditions stabilize and we have greater visibility in the future demand trends, we will reinstitute our guidance.

We are taking several decisive actions that we expect will provide an additional $1 billion of cash available for debt reduction through the end of fiscal 2021. The recently enacted CARES Act by Congress defers approximately $120 million of payroll taxes over the next 3 quarters, which will be paid in December of 2021 and December of 2022.

We plan to make our 2020 incentive payments and 401(k) contributions during 2020 with WestRock common stock that will increase our cash flow by approximately $100 million. We are reducing our capital investments to approximately $950 million in fiscal 2020 and now estimate a range of $600 million to $800 million in fiscal 2021, down from our previous guidance of $1.1 billion in fiscal 2020 and $900 million to $1 billion in fiscal 2021.

We will complete our strategic projects at the Florence and Tres Barras mills over the next 12 months. And while we’ve had to navigate the impact of shelter in place restrictions and the availability of contract and technical resources as a result of COVID-19, we expect to start-up the new Florence paper machine in the second half of the calendar year 2020. The Tres Barras mill upgrade project should be complete in Q2 of fiscal ’21.

At these capital investment levels, we are confident that we will continue to invest in the appropriate safety, environmental and maintenance projects and complete our strategic mill projects while also making investments to support productivity and growth in our business. These reductions will provide $300 million to $500 million of additional cash available for debt reduction through the end of fiscal 2021.

The reset of our annual dividend from $1.86 per share to $0.80 per share will generate a $400 million increase to cash flow over the next 1.5 years. As we adjust our operations and investments to levels of customer demand, we will continue to generate strong free cash flow, protect our balance sheet and have the financial flexibility to execute our strategy.

Thanks, Ward. Against this backdrop of the pandemic, thanks to the outstanding performance of the WestRock team, we supported our customers with a unique portfolio of products and solutions and global reach that they need to get their products to the consumers that need them. We’re executing on our differentiated strategy, and we’re doing it from a position of financial strength and substantial liquidity.

We’re facing unprecedented times, and the outlook in the near-term remains unclear. We’re adapting and executing on our strategy in response. WestRock’s pandemic action plan will enable us to respond quickly to changes in market conditions as we match our supply to market demand. We expect that these and other actions will further strengthen our financial position by providing $1 billion in cash flow available for debt reduction through the end of fiscal ’21.

All of us at WestRock are confident in our value proposition, that we have the right differentiated strategy, the right team in place to navigate this environment and to emerge an even stronger company.

Thank you, Steve. As a reminder to our audience, to give everybody a chance to ask a question, please limit your question to 1 with a follow-up as needed. We’ll get to as many as time allows. Operator, can we take our first question?

George Leon Staphos, BofA Merrill Lynch, Research Division – MD and Co-Sector Head in Equity Research [2]

Thanks for all the details and for all that you’re doing on COVID. I guess the first question I had relates to how you will continue to manage the portfolio of businesses on a going-forward basis. Steve and Ward, it sounded like — and you mentioned it, that there’s significant variability in what you’re seeing in terms of demand trends. It’s hard to say what is secular, what is one-off. Would it be fair to say that once you determine that, that there will be additional actions to optimize operations, the business, the portfolio. And maybe we just heard what we wanted to hear, but it sounds like consumer maybe has a bit more work to be done once you evaluate this because of the issues in preprint and tobacco. So if you could talk to that, and I had a follow-on.

George, this is Steve. I think you more or less answered the question because I think we are going to monitor what’s going on in the market, and we’re expecting there to be shifts over time. I can’t predict what the shifts are going to be. I can’t predict we’re going to look at our system and operate our system and our portfolio in a way to optimize it overall. And I’d agree with you that we have — I’d say what you said about consumer, I think we have more work to do on consumer, I’d agree with that, for the reasons that you…

George Leon Staphos, BofA Merrill Lynch, Research Division – MD and Co-Sector Head in Equity Research [4]

All right. And then as it gets to the dividend, obviously, an important decision. Given the leverage being at a little over 3x, given the covenant headroom that you said is significant and all the other work that you’ve done to improve liquidity, was there something in particular that gave you pause and therefore, catalyze the dividend? Because it looked like you had room to continue paying the dividend. What is giving you the most concern right now in terms of maintaining it at the level it had been previously at? We obviously respect the decision and I appreciate the color.

Okay. George, thanks for asking the question because this is not a liquidity issue at all. And I think you identified the 1 thing. If there’s 1 thing that is affecting all of us, no matter where we are, it’s the unpredictability of what’s going to happen with respect to market conditions. And we just think it’s best for us to be trying to get out ahead of that and make sure we are as well prepared to deal with the uncertainty that we have in the economy and market conditions going forward.

And these actions, and I look at it not — as the dividend is just 1 of a series of things we do. I’d look at the whole package of actions that we’re taking to allow us to navigate the uncertainty that all of us are facing.

George Leon Staphos, BofA Merrill Lynch, Research Division – MD and Co-Sector Head in Equity Research [6]

So part of it could be the capital that you might be required as you further optimize the portfolio over time, would that be fair?

George Leon Staphos, BofA Merrill Lynch, Research Division – MD and Co-Sector Head in Equity Research [8]

So you’re also keeping some powder, obviously, given further moves that you might need to make within the portfolio to optimize operations. That’s 1 of the reasons that it would be good to have additional cash. Is that fair?

Yes. I just look at it overall, it’s a very unpredictable situation, and I think all the actions that we’re taking are very appropriate for us to get out ahead of really a period of uncertainty that we’re all going through.

Mark Adam Weintraub, Seaport Global Securities LLC, Research Division – MD & Senior Research Analyst [11]

Steve, I just want to follow-up on that — the answer on the dividend question, just because I think it’s sort of important for investors to really fully understand. I mean, your point is that it’s — there’s no liquidity issues that you see right now, but presumably, you’re doing this as a — just in case, you’re really not expecting it, but it’s just a very conservative action to, as you say, get out in front of it. Is that really the way to understand it? Because I think a lot of people are going to read it superficially and say, wow, they must be concerned about their cash generation, they just cut their dividend, and that surprised a lot of people.

Yes. So I appreciate you’re asking that. This is not a liquidity issue. I think it’s exactly trying to get out in front of an unpredictable set of events. And then I do think about it very seriously from a stockholder standpoint, and we generate cash that will go to pay down debt, and I think that will accrue to the benefit of the stockholders. So if I’m a stockholder, I think I appreciate this because it kind of allows us cash to pay down debt, which is going to be available to — which is going to accrue to the benefit of the shareholders and it’s going to enhance liquidity and provide us long-term access to the debt capital markets, all of which I think are very important. And the dividend at $0.80 is still meaningful and it’s substantial and it’s competitive to many other investment alternatives.

Mark Adam Weintraub, Seaport Global Securities LLC, Research Division – MD & Senior Research Analyst [13]

Okay. And then just quickly on the — recognizing it’s a very fluid situation. Are there any specifics you can share with us in terms of how demand is looking currently versus where it had been, what your best expectation for May perhaps, where things look like?

Yes, Mark, I’m going to let Jeff respond to that for corrugated and then Pat after that, respond to that for consumer. So Jeff?

Jeffrey Wayne Chalovich, WestRock Company – Chief Commercial Officer & President of Corrugated Packaging [15]

Thanks, Steve. Good morning, Mark. So it’s too early to tell on May I would say that our backlogs in the first week are stable. And I’ll provide as much clarity as I can on the April volumes, understanding that you’re looking for detail in the specific end markets. I just don’t have that granular view as of yet. And then as you mentioned, based on the amounts of our customers’ closing plants temporarily, the volatility in the demand profile, it may not be indicative of what the quarter will or won’t be. So we finished April down about 4%. We started off the month strong with backlogs and then every week progressively got worse. So we have, as Steve mentioned, over 130 customers that either closed or reduced shifts across the business, 4 of our top 10 customers had multiple plants down into late March into early April. So we saw that in strong segments in our processed food and our protein business. That’s U.S. and Canada. And then businesses that we — that serve food service packaging or food service businesses also went down. And then we saw this in end-use segments that were weak like our industrial products and our distribution and paper business, which is a large part.

The business that we exited and the box plants that we closed will remain a headwind. And then we’ve exited some low value sheet business in that distribution and paper area. So that would be a bit of a drag for the next fiscal year as we exit. But again, if you look at the comps, we were up 1.7% in April last year. The market was down about 1.4%. We were up 2.7% in the quarter last year, and the market was flat. So the comps are tough.

But having said that, our business operated very well. We matched our supply with our customers’ demand. The plants ran well. They had very challenging conditions with businesses that were up, businesses were down. We moved business around the plants literally flawlessly. And Steve mentioned our workforce reacted heroically. And so we’re on the long-term confident we can continue to integrate this business and our differentiated strategy on machine sales, preprint graphic sales continue to remain strong. We’re confident in the long-term ability of us to grow this business.

Patrick Edward Lindner, WestRock Company – Chief Innovation Officer & President of Consumer Packaging [17]

Great. Thanks, Steve, and thanks, Jeff. And so I really can’t — like Jeff, I really can’t comment too much on May. I’ll try to give some details for April, in particular, how it matches with the comments that Steve described around the quarter. Essentially, what we saw at the end of the quarter through the month of March really continued into April. We saw solid demand and stability in food, most of the food service grades and applications, beverage and health care. Our backlogs in April on CNK remains strong at 5 weeks and CRB is at about 3 weeks. And so we feel good about — and optimistic about food service, beverage and health care.

We did run into some pretty significant challenges on commercial print in particular. And so maybe I’ll take a moment and just describe that. We were off somewhere in the neighborhood in April, about 50%. That’s about half of the daily sales rate in April as we would typically have, and about half of what we had in February. A lot of that is just really driven by reductions in direct mailing and advertising and some of the gain on sheetfed projects that normally would be strong this time of year, were really just canceled. And so that continued in April. Of course, as we’ve discussed, it’s hard to tell what that’s going to be going forward.

And also, we had some softness in March, in particular, and that continued into April in our high-end spirits probably impacted somewhat by the duty-free. And also in cosmetics and beauty care, these are more probably discretionary, high-value products. And some of those products were viewed as nonessential, and our customers were not running their facilities. And so April, I would say, really continued the trends that we saw in March that Steve had described.

Mark Adam Weintraub, Seaport Global Securities LLC, Research Division – MD & Senior Research Analyst [18]

And if I could — so if you put that all together in April, order of magnitude, what might have looked like? Pat?

Patrick Edward Lindner, WestRock Company – Chief Innovation Officer & President of Consumer Packaging [19]

In terms of consumer specifically? So overall, I would say it really has to break down by each of the individual grades. But I would say April was down year-over-year. Can’t give an exact number right now because it’s too early with the details, but down modestly year-over-year as well as versus March. And you would see — Steve mentioned in his comments, especially around SBS, mainly because impacted by commercial plant that we took about 14,000 tons of downtime, economic downtime in the month of April, reflecting that softness that we had in commercial plant.

And Mark, this is Ward. I would just add, I’d point back to my prepared comments when we said that revenues and earnings would be down sequentially. And normally, we’re heading into a seasonal period in the second half of the year where revenues would actually increase. So I think the comments that both Jeff and Pat gave you on the month are consistent with our view of the sequential decline for the quarter.

For my first question, I wondered if you can just talk a little bit about the order of magnitude of kind of your fiber increases, your recycled fiber increases, since the bottom, which I think was probably in the first fiscal quarter and then your ability to offset those increases.

Jeffrey Wayne Chalovich, WestRock Company – Chief Commercial Officer & President of Corrugated Packaging [24]

Mark, yes. So we’ve had significant increases in our fiber. We’re up probably $50 or so a ton so far. And with — the demand is remaining constant for recycled fiber, but the generation has been challenged. So starting in March, we saw a downturn in generation, mostly because a lot of the business is retails. So the grocery stores remain strong, but the rest of the retail commercial business has really softened up. And then you had a shift to online buying. And so a lot of the OCC into the recycling centers has a much less recovery rate than you have at the retail stores and grocery stores. So that’s caused pressure to the upside. What we’re doing to offset in the business is we run the most virgin fiber or recycled fiber depending on the cost at the mills up to their capability to do that based on balancing energy, based on their capacity pulping, so we manage that as closely as possible to help offset the cost. We reduce — we look at all of our Lean Six Sigma projects. We try to offset inflation by productivity every year. And then depending how far the OCC goes, we’ll continue to try to offset all the costs we can.

And I think at a certain point, if you look back 3 years ago, it was a $300 million headwind that was a bit tough to outrun. But right now, we’re holding our own with offsetting some costs and mixing our — the fiber mix, optimizing the fiber mix based on the cost into the system. And then as we get through the year, we’ll see if this upside pressure persists. I think it persists into May, and then we’ll look at what happens. But as we said earlier, it’s just too hard to predict anything right now in the market-based on the COVID situation.

Okay. That’s helpful, Jeff. The follow-on I had was just around Gondi and I’m curious about both the start-up of the new machine and what effect that may have on your exports into Mexico. But I’m also curious whether there’s anything in the partnership agreement which would have you having to increase your ownership in Gondi, say, between now and the end of fiscal ’21?

Mark, I’ll take the second question. Mark, I’ll take the second question, and Jeff, you answer the first question. There’s nothing in the partnership agreement that would cause us to need to increase our ownership. So we’re stable…

Jeffrey Wayne Chalovich, WestRock Company – Chief Commercial Officer & President of Corrugated Packaging [29]

Mexico is facing the same type of market dynamics that we are, Mark. So the OCC generation low upward pressure, they’re seeing the same effect. So some delay in the mill project based on the COVID situation, so that’s being stretched a bit. And then I would say their end-use markets are very — having the same effect as ours are right now in the U.S. So very similar conditions in Mexico to what we’re seeing here in the U.S.

Mark, we’ll get — we’ll put something on our 10-Q that will specify the answer to the question on Gondi.

Anthony James Pettinari, Citigroup Inc, Research Division – VP and Paper, Packaging & Forest Products Analyst [32]

Just following up on the earlier question to Jeff, is it possible to quantify how long the volume headwind from the closed box plants last? And is it possible to size it? And then, Jeff, I think you indicated April volumes were down 4% with large customers seeing some plant shutdowns. Is it possible at all to kind of quantify the impact of the shutdowns, whether it was a small portion of the decline or half or most of the decline? Just trying to understand what kind of normal organic growth would be.

Jeffrey Wayne Chalovich, WestRock Company – Chief Commercial Officer & President of Corrugated Packaging [33]

Sure. So the first part, Anthony, the box plant closures started in May of last year, and they’ve run-up through January so far. So there’s a — and it’s between 0.6% to a point total for the closures. So as we go through the years, a lot of those will drop off as we move through the year. And then in April, I think the closures were significant. I don’t have the site level detail yet of each end market. But the end markets that were challenged in March remained challenged in April. So distribution sheets, paper, industrial, retailers, food service. And then we had an effect of even agriculture that was up, the parts that go to food service, which is probably not half of our ag business, but it’s still a substantial piece, were down significantly.

If you look at our top 10 customers that you have some major protein customers, you have some major consumer products, goods companies, processed foods, there — that’s a significant piece of some of the headwinds that we faced. So we had, as I said, some of those businesses had over 5 plants, both in the branded consumer, in the private label and then the protein, and that’s Canada and U.S. for us. So those were significant pieces of the downturn.

And then if you look, there’s a chart in our deck on the large segments, when you look at distribution in paper, and I can give you exactly in the March quarter, was down 6.6% per day. And so that remain coming into this business. And you think about big 3 for us, part of their business is auto business, auto parts, that’s down completely. And then the moving business, moving in storage is down significantly also. And that’s 1 of the largest customers, Department of Defense, they suspended all moves for the services through June 1. So that’s another part of the headwind.

So in those large areas, those large segments were down. And even our Pizza segment that has been robust and growing is off coming into April. And I don’t have that specifically yet for April. But the flavor of the segments is basically the same coming into April.

Anthony James Pettinari, Citigroup Inc, Research Division – VP and Paper, Packaging & Forest Products Analyst [34]

Okay. That’s extremely helpful detail. And then just a question for, I guess, for both corrugated and consumer. We’ve seen some states start to lift shelter in place orders and understanding it’s really early days, I’m just wondering, as you talk to your customers, whether it’s in food service or retail or other parts of the business, is this something that you’re kind of seeing as a meaningful catalyst for orders picking up? Or just kind of any color you can give there?

Jeffrey Wayne Chalovich, WestRock Company – Chief Commercial Officer & President of Corrugated Packaging [35]

Sure. I’ll start and then turn it to Pat as a continuation. It’s too early to tell. And as I said, the segments that are even strong are having downtime and headwinds because of the effect of COVID on their employee base. So hopefully, as we start back up, we start to see some trends of demand picking up, but it’s too early to tell in this first week of May. Pat?

Patrick Edward Lindner, WestRock Company – Chief Innovation Officer & President of Consumer Packaging [36]

Yes. And thanks, Jeff. And just adding on the consumer side, I would agree with that. I think the — probably the most dynamic spaces right now that we see are really around food service and cup and plate stock for SBS, where we’re an open market SBS board supplier there. So — but it’s too early to tell really what might happen there, but there’s been a lot of changes. And then the other is still in commercial print, which I mentioned before, has seen some pretty significant declines. And so we’re watching that carefully. But with all the uncertainty that’s out there right now, it’s just too early to really tell whether the state is opening up or some of the activity around social distancing is going to have a meaningful impact in the near term.

Steve, just a question more, maybe philosophically or longer term, just on how you’re viewing acquisitions. Some of the deals that were done this most recent cycle, they don’t seem like they’re performing too well in the downturn, MPS with some of the high end spirits and tobacco and KapStone, you mentioned some of the challenges in victory. Obviously, the leverage got to be a little bit too high, and we’ve now had to cut the dividend. So just longer term, obviously, that’s been a value creation lever for WestRock was acquisitions. But do you think that going forward, maybe we’ll be a little bit more circumspect and maybe the leverage won’t be as high as it’s been in the past and maybe acquisitions will take more of a backseat to reducing leverage for the foreseeable future?

Thanks for asking the question, Brian. I think with respect to capital allocation, from where we are, I think debt reduction is prioritized over acquisitions. But I expect over the long term, we’ll be able to make acquisitions to add value to our company.

Okay. And then just sort of related to that, you’re taking a lot of steps to generate cash and improve liquidity. Just within the portfolio, are there any assets you might look to sell or divest to try and accelerate that process? And are there any other sources of cash you might be able to pull, like, say, from working capital? I think initially, that was going to be a pretty big headwind for the year, but things have changed. So just wondering if there any other avenues to generate some cash in the near term?

Yes. We look at our business as — our job is to generate cash, so we’ll look at all alternatives. We don’t have anything specifically on our portfolio that stands out. I think I’m looking at Ward Dickson and John Stakel and they look at working capital each and every day. So we’re looking at the various levers to — that we can to generate cash.

This is John on for Mark. Just first off, could you just talk through the bleached board business and how — talk about how far we are from earning cost of capital? And then what the overall bleached board operating rate was during Q1?

Patrick Edward Lindner, WestRock Company – Chief Innovation Officer & President of Consumer Packaging [44]

Yes. So this is Pat. So around bleached board and SBS specifically, so as Steve commented, tobacco and commercial print has been in a secular decline, and we’re seeing some near-term challenges as it relates to commercial print, also a little bit on food service. So we did take some unusual economic downtime in March and April, indicating that our operating rates were not as high as they have been prior to that.

Now coming into that period, I would say that we were pretty strong. And it was, as you would expect, with SBS, with operating rates being up and backlogs around 4 weeks as typical. But clearly, what we’ve seen in some of the segments that we participate in that use SBS or bleached board in general, we’ve seen those adjustments in those downturns over the last couple of months that have certainly impacted the operating rates.

Okay. That’s helpful. And then turning just to MPS more specifically. You’ve called out European weakness but what parts of MPS business are weaker? Is there anything in addition to high-end spirits?

Just — this is Steve. I think their footprint in Europe is weighted toward Britain. So they’ve had some — and so I think Brexit has been a challenge for them. And so we’re moving that production as far east as we can in Europe. So we’ve moved business to Poland. I think the segments are really not that much different than we see overall. The health care business has done very well. And the consumer branded business has been more challenged because of what Pat said about the duty-free stores and just I’d call it, the COVID related business.

I hope you and your families are doing okay. Curious if you could comment at all about trends, specifically in the corrugated business in Brazil. I appreciate it’s going into a seasonally slower period, but what we’ve read thus far even through April had seen and indicate some pretty strong demand down there.

Jeffrey Wayne Chalovich, WestRock Company – Chief Commercial Officer & President of Corrugated Packaging [49]

It’s Jeff. I’ll take that. So Brazil, I think what you’ve read is consistent. They have positive containerboard sales up year-over-year, almost 11%. Higher exports in the South America region into Africa also. Volumes are up 7% for our Brazil business. They outperformed the market, but that grew at a healthy 6-plus percent. The Porto Feliz ramp up continues to go extremely well. They continue to grow the business. They’re setting records on their new corrugators and EVOLs and that ramp up continues to go extremely well.

We’re seeing some headwinds from the COVID virus, but it’s not to the extent to date as we’ve seen here. Also, the Tres Barras project is on track and scheduled to start-up, as Ward said earlier, in the first half of calendar 2021. We took a short delay, a 10-day delay, based on some government actions, had demobilized, but it’s back up and running and on track. So that business overall continues to perform very well, and their markets continue to stay strong right now.

And the next question, I guess, on pulp. You mentioned it being a $20 million headwind, I guess, to the first half year. There’s been a series of price announcements that we’ve seen. Just curious from a timing standpoint, how we could see that phase in, that’s more of a fiscal 2021 benefit? Or if it’s maybe more immediate because you sell into the spot market?

Patrick Edward Lindner, WestRock Company – Chief Innovation Officer & President of Consumer Packaging [51]

Yes. So maybe I’ll take that because it’s in the consumer piece. And so majority of the pulp we make is in our SBS system as we balance it — balance that system with some open time. The — our pulp volumes have increased recently, as you can see in some of the appendix material that we’ve published. And as you know, prices have declined, published prices have declined in pulp. So that’s had a significant impact on us across the segment. As far as what could happen in 2021 or beyond, it’s very difficult for us to project with all the uncertain everything, we would not be able to do that. But with — certainly, March and April and going back really for this year-to-date fiscal year, it certainly had a pretty significant impact, so it’s just really driven by the pricing dynamics in that market as previously published.

I mean, Gabe, for us, it’s a small part of the business, as you know. But sequentially, we have seen some upward movement in our pricing. It’s down still year-over-year. But last quarter to this quarter, we have seen increases in the pulp.

So just quickly back on capital allocation. We understand what you’ve done with the dividend and why. Can you remind us if you have a specific payout ratio? And on a related question, you didn’t mention anything specifically on the repo. We know you’re going to use the stock to fund incentives. But can you remind us how much availability you might have on the repo?

We have about 20 million shares, and we haven’t repurchased shares in quite a while because we’ve been very clear that our capital allocation priority has been debt reduction.

Patrick Edward Lindner, WestRock Company – Chief Innovation Officer & President of Consumer Packaging [59]

Yes. Yes. The dividend, I’ll tell you, we kind of spent a lot of time thinking about what the right level was. And it’s hard to specify a specific payout ratio. I look at the $0.80, it sounds as it’s $200 million. We can generate $200 million and should be returning $200 million to our shareholders and under any scenario that we can imagine. And as we said in the prepared comments, we’re going to look at increasing that as things get more visible. And so I think, it’s really hard to talk about a specific payout ratio in this environment.

Got it. And then my second question, 1 of the secret sauces for WestRock, at least in my opinion, is the machinery installations that you have in your clients’ facilities. So is it getting tougher to serve those machines? Or once they’re installed, is it up to the client to maintain the machines?

Jeffrey Wayne Chalovich, WestRock Company – Chief Commercial Officer & President of Corrugated Packaging [61]

This is Jeff. So the COVID experience has made it a bit tougher to do that. But no, we are sending out text with PPE kits, face coverings, gloves. We talk to our customers on their requirements in the plant and then our requirements. So we do have normal service contracts that we’re fulfilling and then also any emergencies where the customers will need us. So that part of the business we continue to move people through and safely. We’ve had great success doing that. And our sales in that — in our machine business has continued to grow. As Steve reported early, we’re up over $300 million in the last 12 months. So excitingly, that continues to grow, and we continue to grow the business in that market and serve those markets.

Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division – Director and Senior Equity Research Analyst [63]

Jeff, just going back to your April commentary for a moment. I just wanted to ask a couple of things. So I think you said shipments were down for and the backlog had declined over the course of the month for precisely that reason. Can you just give us some sense of what your containerboard mill backlog is now compared to what it was at the beginning of April, just to pick a date? And then on the e-commerce piece, given that e-commerce is really stronger than food service is suffering, do you have any sense of what the net impact of the e-commerce growth is to the extent that it’s basically replacing the lost food service business?

Jeffrey Wayne Chalovich, WestRock Company – Chief Commercial Officer & President of Corrugated Packaging [64]

Well, so I’ll start with the last part. The e-comm business is up strong double digits, and that’s remaining. And you have the large growth in online and also buy online and pick up in store, which was the fastest-growing segment in the e-comm space from March into April. As far as the food service and an offset, it’s hard to say as a percentage because there are so many different businesses that supply into food service, dairy, bakery, agriculture. So it’s hard to say what an offset would be as an exact amount.

As far as the backlogs, we look at the backlogs in the box system. And so we’re — it’s a 5 to 10-day backlog. And as I said, coming into May, there was a stabilization from April and a bit of a pickup from what we saw in the second and third week in April, but it’s too early to tell if that’s a trend or not right now because of the volatility in our markets.

Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division – Director and Senior Equity Research Analyst [65]

Yes. I appreciate it. And just 1 other 1 on e-commerce, which is, over the last 3 years, it’s been a strong grower, a double-digit growth, during which time, box demand went from growing by 3% back in ’17 to basically flat lining last year. So I’m just wondering what impact do you think e-commerce growth is having on the overall market when it seems as if e-commerce remains super strong, but box demand has flatlined over the past few years?

Jeffrey Wayne Chalovich, WestRock Company – Chief Commercial Officer & President of Corrugated Packaging [66]

I think it’s just — it’s based on the percentage that e-commerce is right now of the overall box market, Adam. So if you look at the total, if it’s 10% to 12%, I think that’s probably just a function of the total in e-comm. And then you have substitutions, you have smaller packaging, you have sign-up, there’s a lot of other things that go into that. But I think still that if you look back at durable growth, non-durable growth, those things, some of the non durables have been challenged. And in this environment, it’s even more challenged because of industrial. But our ability to grow across segments over the last 3 years has been very good. And for our business, I’m positive that we can continue to grow in the markets, given the short stint of COVID here, hopefully, that over the long term, we’ll continue to grow and win in our marketplace.

Thank you, operator, and thank you to our audience for joining today’s call. As always, reach out to us if you have any questions, we’re always happy to help. Thanks, and have a great day.

Post time: May-11-2020
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