International Paper Co (IP) 2018 Q3 法說會逐字稿

Good morning, and thank you for standing by. At this time, we would like to welcome everyone to the International Paper Company third quarter earnings results conference call. (Operator Instructions) It's now my pleasure to turn the call over to Guillermo Gutierrez, Vice President, Investor Relations. Sir, the floor is yours.

Thank you, Holly. Good morning, everyone, and thank you for joining International Paper's Third Quarter 2018 Earnings Conference Call. Our key speakers this morning are Mark Sutton, Chairman and Chief Executive Officer; and Tim Nicholls, Senior Vice President and Chief Financial Officer.

There is important information at the beginning of our presentation on Slide 2, including certain legal disclaimers. For example, during this call, we will make forward-looking statements that are subject to risks and uncertainties. We will also present certain non-U. S. GAAP financial information. A reconciliation to those figures is available on our website. Our website also contains copies of the third quarter 2018 press release and today's presentation slides. Relative to the Ilim joint venture and the Graphic Packaging investments, Slide 2 also provides context around the financial information and statistical measures presented on those entities.

I will now turn the call over to Mark Sutton.

Thank you, Guillermo, and good morning, everyone. We'll begin our discussion on Slide 3. International Paper delivered very strong performance in the third quarter, with more than 50% earnings growth year-over-year and building on our solid performance in the first half of the year. We expect the momentum in our businesses to continue into the fourth quarter and into 2019.

Coming back to the third quarter, we had solid commercial performance and continued price realization across our 3 businesses. And overall, we see continued healthy demand for our products globally. We are facing cost headwinds from distribution and most of our inputs, but again, we see this as a reflection of the strong economy that we're operating in and the healthy underlying demand for our products.

Our operations performed well in a lighter planned maintenance outage quarter and our teams managed extremely well through Hurricane Florence. Tim will cover the financial impact of Hurricane Florence in more detail, but first, I want to thank the employees in our company, who were impacted by the historic storm, for their commitment to prepare, recover and restart our facilities safely and clearly in the face of their own personal hardship. I'm also very proud of the response by the IP family. IP and our Employee Relief Fund provided $1.8 million in emergency funds at the time it was needed to more than 1,200 employees to assist them with basic needs in the aftermath of the storm. I think this is a great example of what we call the IP Way: Doing the right things in the right ways for the right reasons, all of the time.

Turning to the financial results on Slide 4. Revenue increased by more than 7% year-over-year on solid commercial performance and continued healthy demand. EBITDA improved by nearly 18% year-over-year, with very strong margin expansion across our 3 businesses.

Our North America Industrial Packaging business performed very well. We are ahead of industry volume growth in the third quarter, driven by our focus on segments that are benefiting from strong secular growth trends. Our Global Cellulose Fibers business delivered record fluff pulp shipments in the third quarter, despite the impact of Hurricane Florence. And our Papers business delivered very strong results globally, with outstanding commercial and operational performance.

Our equity earnings in the quarter were $92 million, which includes $74 million from our Ilim joint venture and $19 million from our ownership interest in Graphic Packaging. Free cash flow accelerated in the third quarter on very strong cash from operations and lower CapEx versus the second quarter, as we expected. All in, the company delivered a very strong performance, and we managed extremely well through the hurricane.

I'll now turn it over to Tim, who will cover the performance across our 3 businesses as well as our fourth quarter outlook. Tim?

Thank you, Mark. Good morning, everyone. I'm on Slide 5, which shows our quarter-over-quarter operating earnings per share bridge. Operating earnings improved $0.37 sequentially driven by strong commercial performance and lower planned maintenance outage expense. Third quarter results were negatively impacted by $36 million related to Hurricane Florence. During the quarter, we also had a favorable one-time true-up of $24 million across all businesses that will not repeat in the fourth quarter. This was mainly related to lower health and medical benefit costs. And in operations and costs, we also had higher expenses related to the Madrid mill start-up. Input costs and distribution were unfavorable, with higher costs sequentially across most inputs. The distribution environment remains very tight and our businesses continue to work aggressively to mitigate the impact. Corporate expense and taxes were favorable, with a 24% effective tax rate driven by discrete tax benefits in the quarter. Lastly, equity earnings were higher sequentially despite a noncash FX charge on Ilim's U.S. dollar-denominated debt, which works out to be about a $0.06 deduction to our EPS. As Mark said, it was a very strong performance for the company.

Turning to Slide 6, I'll provide more details on the financial impact of Hurricane Florence. As I mentioned earlier, we had a $36 million impact in the third quarter, which includes $8 million in volume and $28 million in operations. Looking ahead, we expect a $15 million impact in the fourth quarter, mostly in our Global Cellulose Fibers business.

With regard to insurance recovery, we're currently working with our providers to determine the potential recovery, but do not expect any material proceeds in the fourth quarter. I'd also point out that the hurricane is deemed as a single event, so our deductible will be $20 million across the enterprise.

So I'll start with the segments on Slide 7, first with our North American or Industrial Packaging business and in North America, the business performed very well, delivering $622 million in earnings and a 24% EBITDA margin. By the end of the quarter, we had realized 90% of our recent box price increase and overall, we continue to see healthy demand across all channels. I'll have more on that in just a minute.

Input and distribution costs were a headwind in the third quarter across most inputs, including recovered fiber, which increased by $14 million sequentially.

Performance in our European packaging business was impacted by start-up and commissioning costs as well as the overhead burden of a mill that was not at a full ramp. All in, that was a $25 million impact in the quarter. Additionally, box demand was seasonally lower, and we expect -- we experienced especially weak fruit and vegetable demand due to adverse weather conditions.

A brief update on the Madrid mill. The mill started up in the quarter, we're making progress as we go through the checkout and test phase and we'll continue to ramp up operations and production as the quarter progresses. Overall, we're confident in the business fundamentals and very pleased with the strong performance in North America and momentum in the fourth quarter. In Europe, we anticipate seasonally stronger demand and we'll start capturing integrated margins on recycled containerboard as the Madrid mill ramps up.

Coming back to the North American packaging business on Slide 8. An important contributor to our strong performance is our deliberate focus to serve the fastest-growing segments and be aligned with the best customers across all segments. While our scale and footprint enables us to serve just about every corrugated segment, we are leading the way in e-commerce, fresh produce and protein. Across the business, we have segment-specific innovation teams who work with our customers to develop value-creating packaging solutions. This is ultimately how value is created from fiber to the consumer, and it is a driver of why our box shipments are outperforming the industry as reflected by our third quarter box shipments, which were up 1.5% year-over-year on a blended basis.

On Slide 9. The Global Cellulose Fibers business delivered earnings of $85 million and 21% EBITDA margins in the third quarter driven by strong commercial performance and price realization across our portfolio. As I mentioned before, Hurricane Florence impacted results in the business by $28 million, which includes a $7 million impact to volume. Even with the hurricane, the business had record fluff pulp shipments of 8% growth year-over-year in third quarter. Our strong growth is driven by understanding and addressing our customers' needs.

We have a unique and powerful innovation engine and an unmatched service model with global reach and local execution. And our multi-mill system allows us to deliver the value to customers in the fast-growing absorbent markets around the world. Part of that mill system advantage comes -- goes back to the conversion we undertook at Riegelwood in mid-2016. For us, it was the right decision at the time and has then enabled us to support the strong growth we see today. We've delivered more than 450,000 tons of fluff pulp to our customers from Riegelwood, which is right in line with expectations.

Moving to Printing Papers on Page 10. The business delivered outstanding results globally on strong commercial and operating performance as well as lower planned maintenance outage expense. EBITDA margins were 23% across the segment, with all regions contributing to a small -- strong quarter. Input costs were a headwind in the quarter and year-over-year driven by higher wood, energy and chemicals and in North America, distribution costs remain a challenge. Overall, an extremely good quarter across all geographies.

On Slide 11. The Ilim joint venture continues to deliver solid financial performance, with operating EBITDA of $297 million and an EBITDA margin of 45% in the third quarter. That's before foreign exchange charges. Volume was down sequentially due to heavy planned maintenance outages in the quarter. IP's equity earnings were $74 million and were impacted by a noncash foreign exchange charge on Ilim's U.S. dollar-denominated net debt, of which IP's after-tax portion was $23 million.

Taking a look at year-to-date performance. Operating EBITDA through the third quarter is $898 million, almost double last year at this time.

So turning to the outlook on Slide 12. In our Industrial Packaging business, we expect to see the last part of the recent price increase in North America. Volume is expected to be a $10 million benefit from stronger seasonal demand in North America and Europe. Operations are expected to be flat sequentially as improved mill operations and lower Madrid mill expenses are offset by the non-repeat of the third quarter true-up I mentioned earlier. Staying with Industrial Packaging, outage expense will be $57 million lower and input costs are expected to be stable.

In our Global Cellulose Fibers business, additional price realization will be largely offset by geographic and product mix in the fourth quarter. Volume is expected to be a $5 million benefit and operations are expected to improve by $5 million. Outage expense will be $3 million higher in the quarter.

In our Printing Papers business, we expect to see a $10 million benefit from our recent price increases and improved mix. Volume is also expected to improve sequentially on stronger seasonal demand in Latin America and Europe, with an expected benefit of $10 million.

Operations are expected to be a $15 million headwind in the quarter. This includes approximately $10 million of currency headwinds in Brazil. Outage expense will be $3 million higher and input costs will be a $10 million headwind, largely due to higher wood cost in Brazil and Russia.

Under equity earnings, you will see the outlook for our Ilim joint venture and investment in Graphic Packaging, and in other items, we include corporate and interest expense in our estimated effective tax rate for the fourth quarter.

On Slide 13, turning to capital allocation. Last quarter, I shared with you our capital allocation framework in more specifics on how we will maximize value creation. Want to take a moment to update you on recent actions and provide additional clarity on what you can expect from International Paper. So let's start with the balance sheet.

In the quarter, we took a couple of actions to derisk our pension plan and further reduce our exposure to our pension liability. First, we executed a pension liability transfer of $1.6 billion, which was funded entirely with plan assets. We also, based on improved funding levels that we saw as we were exiting the quarter, we decided to adopt a more conservative approach on asset allocation, increasing our fixed income investments and reducing our allocation to equities. The key takeaway here is that we see no funding requirements on the horizon.

As I said last quarter, we will maintain a strong balance sheet and an investment-grade credit rating with a target debt-to-EBITDA of 2.5 to 2.8x on a Moody's basis. We are currently at about 2.9, so improving our leverage ratio is a priority.

Turning to cash back to shareholders, returning cash is a meaningful part of our capital allocation framework, and it will be as we go forward. Earlier this month, we increased our dividend by 5.3% to $2 annually. This is the seventh consecutive annual increase since 2011 and reinforces our commitment to a competitive and sustainable dividend of 40% to 50% of free cash flow. Also, earlier this month, our Board of Directors authorized a $2 billion share repurchase program. This is incremental to the $400 million remaining from a previous authorization at the end of the third quarter. And in the third quarter, we completed $200 million in share repurchases. Going forward, you can expect our share repurchases to be thoughtful and have a consistent cadence based on value.

Turning to investments, and as we committed last quarter, M&A will be disciplined, selective and compelling. And we will invest to create through organic projects that are grounded on clear strategic and financial logic. Currently, for 2018, we are expecting that our spending on capital will be approximately $1.6 billion due to the timing of spend on very attractive strategic projects. And staying on the topic of capital allocation, I'll turn the call back over to Mark.

Thanks, Tim. And on a related topic, I'd like to cover in this section of our call, I want to share with you an update on our portfolio. After careful consideration, we have decided to explore strategic options for our Brazil packaging business, including the possible sale of the business. Essentially, we've concluded that we cannot competitively serve the Brazil packaging segment with the structure of our existing business. We plan to provide appropriate updates as we go forward. And coming back to Tim's remarks on capital allocation, to me, it's all about value creation. That's what drives our decisions. Our approach to capital allocation reflects our confidence in International Paper's strong free cash flow generation and our long-term outlook.

Turning now to Slide 14. I want to take this opportunity to share my views on International Paper and our performance. We delivered a very good third quarter and are well-positioned for a strong fourth quarter, with momentum as we move into 2019. We see continued healthy demand globally for our products. But that's not the whole story. The way I see it, it all starts with our customers and our focus on commercial excellence. There's a lot behind those words. It's all about making sure we have the customer relationships and the best value chain to solve their needs. From fiber to box, from fiber to fluff pulp and from fiber to paper, it's about International Paper's unique capabilities to solve our customers' unique needs. And speaking to packaging specifically, we're very confident in our ability to provide our customers with the best packaging solutions, because ultimately, that's what matters, to be the preferred partner to develop and supply the actual package. Across all of our businesses, we have unique capabilities to thrive through just about any challenge we may face. We have the people, the innovation, the products and a low-cost, high-quality manufacturing system to succeed with our customers.

And with that, we're ready to take your questions.

(Operator Instructions) Our first question is going to come from the line of Steve Chercover, D.A. Davidson.

Two quick questions from me. First of all, it's good to know you still have about 10% of the containerboard price hike yet to be realized. And I'm just wondering, is it your client mix that is maybe a little slower in implementation than the competition?

Yes, Steve, it's Tim. It's all based on contracts and the negotiation around those contracts as we go through the implementation. So it's, for us, it's kind of a normal type of implementation across the mix of business that we have. And if you remember, going back to the second quarter, we actually were able to accelerate part of that realization at the end of the second quarter. And then I think the third quarter followed right as we would have expected it to.

Great. And then also on containerboard, but this time in Europe, the operating profit is a little bit disappointing, and I know that part of that is due to the Madrid start-up, and that'll be ultimately part of the solution. But is the margin differential between Europe and North America also somewhat attributable to like your transfer pricing of the board that you ship from North America across the pond?

I'll take the transfer pricing question and then Mark probably wants to comment on the margins in Europe. We transfer at market. So we are in the open market, we are shipping board to our integrated business and everything we do, whether it's here in North America or other parts of the world, we're always attempting to be right on top of the market price as we think about how we sell to our integrated businesses.

Steve, this is Mark. On the plan we have for Europe, we see the combination of the competitive Southern European-focused box business with the integration of our high-performance Madrid mill and the integration of U.S. kraftliner into our kraftliner segments. As Tim said, the profit for that shows up in the U.S. business. We see our business being able to get to competitive European EBITDA margins. Now remember, there's always going to be a gap in EBITDA margins. In a North American context, you got a lot more capital employed with virgin mills than you do in Europe. So working toward a cost of capital return, you get there with lower EBITDA margins in Europe than you would in a higher CapEx environment that you have in North America. But in North America, you generate your own energy, you have a different cost structure, so you trade capital for operating costs and the goal is to create value by getting well above our cost of capital in both business models.

Our next question is going to come from the line of Adam Josephson, KeyBanc.

Mark or Tim, just my first question on your demand. You're up a healthy 1.5% in the quarter. Did you see anything -- have you seen anything much different in October? And were you at all surprised by the slowdown in the rate of industry growth as the quarter progressed?

Yes, I mean, our quarter -- Adam, it's Tim. Our quarter, we felt very good about, it was very strong and we see it continuing into October into the fourth quarter. So we only know what we see in terms of the segments that we're exposed to and the customer mix that we have. And as I pointed out in the comments, we have -- we think we have the best customers across all of our segments, but especially within these faster-growing segments, very well-positioned. So right now, as we're in October, it feels like our third quarter momentum has continued.

Mark, just one question on vertical integration. I think you addressed this on the last call, because there was a capacity addition announced on the day of your 2Q call and the question of vertical integration came up. The open market is supposed to be pretty small, but obviously, we've seen 4 capacity announcements in recent months from non-integrated producers and the obvious question is where is all the paper going to go? What are your thoughts about that issue, and why the limited open market has not prevented this number of capacity announcements of late, appreciating that we don't know for sure that they'll all come on, but assuming they will?

It's a great question, Adam and I think your last qualification is a valid one. We don't really know how all of the capacity will play out. But as I said in my remarks, what really matters is the actual packaging solution, the box and the supply chain services you provide for customers. So being an open-market provider of 1 or 2 grades of containerboard, you might find a place in that value chain, and you might not. And I think the last time, in the 2015, 2016 period where some capacity was added by different types of industry participants, including non-integrated, we saw a wide range of outcomes, from complete failure to being acquired by a vertically-integrated company and everything in-between. And I think we're probably going to see some of that here as well. The way I look at it, though, Adam, the big picture is, containerboard globally is growing. And the virgin containerboard that's made competitively in the U.S. primarily is going to feed a lot of the fiber needs. There are some dislocations right now, but I think we're going to see that mass balance of fiber to where packaging is made settle out over time, because the corrugated box is a really good packaging solution for so many different segments. So I think that's what's going to happen. I said that and others said that in our company when we met with investors a few years ago. It sort of turned out that way. So I guess we will have to see how things transpire over the next couple of years, but I feel really confident about the supply chain, the value of integration, because it's what addresses the customers' need.

Our next question is going to come from the line of Gabe Hajde, Wells Fargo Security.

Question on inventories and where you sit today, and we've heard a lot about increased distribution costs and such. And it doesn't look like that's going away anytime soon. Just how you feel about inventories in your system and high operating rates as we look at industry data, how that might persist through the fourth quarter?

Gabe, it's Tim. We feel better about our inventory levels now than we have in a long time, just based on a string of events, and whether it was natural disasters or specific issues that impacted our mills. We spent most of last year and much of this year really working our supply chain hard to get back to more sustainable levels of inventory, at a time when you had all of the transportation issues, first rail and then truck and so it's been timing, to get product where it needs to go, but it's also been sourcing the right kind of transportation at the right time. So I would say across our channels, we've been chasing to catch up on orders, especially in the export markets, and also working hard to get back to a sustainable footing on inventory levels and feel like we're just now beginning to get there.

Our next question will come from the line of Chip Dillon, Vertical Research.

Mark and Tim, if you could just clarify the year for the CapEx number, the $1.6 billion, and then my main question is, the -- if you look at industry data, obviously, we've seen a surge of export activity in the last quarter. I think September was the highest for any quarter on -- any month on record. And I just wanted -- it would be one thing if we were seeing a soft economy, and you guys weren't running your mills to the max, but looking at the operating rates, it would seem to suggest that there was actually a desire to get board out there and I just didn't know if you could help us understand what's causing the export market to be so attractive to make such a stretch to supply it?

Well, I think you've seen, Chip, it's Tim again, I think you've seen the price realizations over a period of time. But demand has been and continues to be very strong across all of the geographies that we serve. And we've always thought of export as something as a strategic channel to market for us, especially with a core group of customers. Part of what we've been doing, as I referenced in the response to the last question, is just catching up on orders as backlogs had extended out in time. So we see -- we saw healthy demand in the quarter. We continue to see healthy demand. I think that continues as we exit 2018 and go into next year and it's been that way for several years in a row now. So this is not something that's new. The demand has been there consistently. On the capital spending, it's really timing. We were a little bit lower last year than what we had guided to and part of that has spilled over into this year. And so we're thinking that it's right around $1.6 billion in 2018 after being $1.4 billion last year.

Okay, this is my follow-up. Could you talk a little bit about maybe what CapEx will be next year and in the context of that, if you think about it, the after-tax dividend yield, at least last night, was over 5% and I know your after-tax borrowing costs are well below that. So just any thoughts about how that impacts what you were saying about buybacks?

Yes, I think -- I don't want to try to forecast for people about what we will do. I think we've laid the framework out, and we see the same numbers that you see. And so I think the approach that we're taking is we're reporting after the fact what we've done in the quarter and let those actions speak for themselves over time. And the other part of your question about 2019, we're still working through numbers. It will be lower, but we don't have a number that has been finalized at this point. We normally put that out at the end of the fourth quarter, when we release in January.

Okay. So despite the Riverdale project, it'll be lower.

Our next question will come from the line of George Staphos, Bank of America Merrill Lynch.

I want to take 2 questions, one from a packing standpoint and then I want to drill back into dividends and cash flow in a minute. Obviously, you showed better than industry growth this quarter, and I guess, that'd be one way to measure it. But could you provide some sort of quantification or qualitative view on how you're trying to distance your packaging business versus others? And the reason I ask that, I mean, to the earlier question about paper capacity coming in and the merchant channel being constrained because of all the buyouts that have occurred. In theory, somebody could also start opening up box plants and then could have more independent capacity available as well. So how do you quantify, how do you create a moat around your box business and grow that share versus peers, from a performance standpoint?

George, this is Mark. That's a great question and it's sort of embedded in those words we used in our prepared remarks. But when you think about all the different types of segments that go into the corrugated packaging market and what different customers need, we have the ability, starting with the base material of containerboard, to design the exact right package uniquely for that customer's need. And in some cases, that's combining 3 or 4 different types of grades into a final package, and we control the making of those grades and the quality that goes into that. You can trade off specs on the inside of the box versus the outside and all of those types of things are what we bring to the customer. In other cases, customers want additional services beyond just the physical package. They want supply chain services, maybe some fulfillment services. In some cases, our smaller customers want help inside of their plants with health and safety and reliability. So when we go to market, we study every customer, what we can offer, what their needs are, and we look for where there's a match and where there's an unserved need. And then we go out and we prepare something that really is compelling for our customer. So when Tim talked about the high-growth segments and the customers within those segments, there is a lot of analytical work that goes on in that process of us targeting the segments that we believe will be here in the future and the customers within those segments. And so it's not just the physical box. It's a lot of the, what we call, value-added services for our customers, that we hope make our relationship with those customers pretty sticky.

As an aside, do you feel you still have more opportunity to get paid for the additional service components? Or you feel like you're getting fair value for that? And then my other question to the dividend, and recognizing your commentary today suggest you're comfortable in your outlook and the momentum into 2019 and yes, the stock's up today. But when the stock is at $40 a share, the dividend yield is 5% and that is typically a level where people are really beginning to worry about the macro outlook going forward. Not that you're preparing for this, but could you remind us how quickly, and to what degree could you reduce CapEx, if you needed to, if they were something on the horizon that we're not all seeing yet and why -- and what issues you may have and then securing the dividend through the cycle?

George, this is Tim. Just on capital, I mean, go back and look at what we've done in prior periods, all the years are different and circumstances are different, but I think we've demonstrated over time a level of flexibility where we can manage capital in the moment if we absolutely have to.

And George, I would add on that, though, the context to your question is about how do you operate, what's your flexibility in a differing economic environment, a downturn or something like that. It's more than just capital, though. We've got a cost structure that has a high component of variable costs that we can adjust based on demand and you've seen us do that in the past. And we've worked very hard to make our marginal economics model for how we buy every input and how we schedule machines and what we make. And when we make less, the majority of our costs are variable, they go away. And so we've got the ability to manage our cash flow, which is what I meant when I say we're well-positioned to deal and thrive through almost any set of conditions that are out there, especially on a relative basis. And part of that is just the scale of the company and the ability for us to be able to make decisions in high demand periods, in medium demand periods and in low demand periods. So we feel good about that flexibility, beyond just the ability to temporally cut capital, it's much more than that.

And our next question will come from the line of Debbie Jones, Deutsche Bank.

Two questions. I jumped in late, so I wasn't sure if you mentioned October volumes to date and then if you could just comment on any kind of regional differences that you're seeing, East or West Coast, related to ag or whatnot?

Debbie, it's Tim. Yes, we did cover it a little a few minutes ago, but the synopsis was that we had a strong quarter in the third quarter. We've actually outperformed market all year long, based on a lot of the factors that we talked about in the commentary. And we see that momentum continuing in October as we've gone through the month. So I think you could look at third quarter and see a similar type of result so far.

Sorry, about the repeat. But my second question, you have touched on this as well, but just kind of broadly speaking, I actually think it -- it's actually not that surprising that you're seeing a lot of international players looking to build capacity in North America, just given the increasing environmental restraints, higher cost of production that you're seeing with wage increases and things like that. And I'm just wondering if you think about getting more involved and kind of taking control of the supply that's going offshore. And what you would need to feel more comfortable about that? Because I think a lot of the concern for investors is just who's adding the capacity and not really understanding what they might do with it.

So Debbie, that's a great question. I think there's all types of companies that have announced intentions to make some containerboard. I think the fundamental issue that I always come back to, and we come back to in International Paper is, that the global fiber trade is a global business and virgin fiber primarily, but not only, but primarily out of the U.S., some in Latin America and some in, let's say, Russia and Northern Europe, seed the -- is the feedstock for the global packaging business. The markets are growing more in parts of the world that use recycled fiber, as we all know. I mean, recycled fiber depending on where it comes from originally, was new fiber to begin with. So it's not 2 separate universes. And so it would be expected, as the global packaging market grows, to see possibly more fiber being generated out of the competitive market. So if OCC was working before and now it's not because of environmental concerns, then taking that fiber one step earlier in the process, cleaning it up and making it recycled pulp or something, and then feeding the box markets, is another business model. Is it cost competitive? I think that's the way markets are designed. We'll have to see, but if there is no other option because of environmental concerns, then it becomes the standard. So it's about moving fiber to the places where packaging demand is growing, and I think that's what we're seeing playing out. And we're a major participant in that. We've generated very strong margins, many times best-in-class margins, as a long-time participant in these global fiber markets when in some cases, they're not quite as attractive as our domestic box business. But over time, you can see that we've built this channel strategy that's developed into a very strong global competitor.

Our next question will come from the line of Dr. Mark Wilde, BMO.

Got a couple of questions. First, I understand that Amazon is starting to make some changes in requirements for packaging from some of their customers beginning in 2019. I think this is more on some of the heavier-weight products that they move. Could you just talk about that, talk about the implications for IP?

Yes, I don't think we want to talk about customer-specific items, Mark, to be honest.

Well, it sounds like this affects, like, maybe 1,000 vendors into Amazon and sort of what they're going to have to provide in terms of packaging. So I think just as -- for the market as a whole, it's a fairly large potential issue.

Yes, and you know, we work closely with all of our customers and I just -- I think on principle, it's better if they speak for themselves, and we don't try to. So we're very close with a lot of our customers, all of our customers in e-commerce, we understand the trends, we're working closely with them. I think the key there is that because we're viewed as a leader in the space, they seek our involvement and input and so we feel like we are on the front-end of a lot of the innovations and changes that come about and I would just leave it at that.

Okay. And Mark, just coming back to kind of Debbie's question. I'm just kind of curious, if you think about the cost of making paperboard packaging, next to fiber, energy is usually the second biggest variable cost. So I'm just trying to understand longer term, how you think it makes sense or if you think it makes sense, to basically be passing fiber for recycled packaging through 2 energy cycles? You've got to produce the recycled fiber here in the U.S. and dry it and then presumably, you're sending it offshore to be re-wetted and turned into paperboard and then going through a second energy cycle. It just -- it kind of puzzles me how long term, that makes good economic sense.

I think that's a great observation, Mark. And it wouldn't seem to make great economic sense, but you always have to measure that value chain against the alternative. And if you have nontariff and tariff barriers, so other costs that are not operating costs, that raise the cost of your alternatives, one being OCC, one being tariffs on finished products, then the economics change. Is it long-term sustainable, maybe not. But you've got a burgeoning packaging market in a part of the world that's struggling to get fiber. So in order to survive and provide products for customers, you may do something that raises your costs for a while. And I just think as you look at what makes it economically viable, it's what are your alternatives and right now, there are limited alternatives for moving fiber without that extra step of cleaning, basically.

Just to kind of complete this thing, would you worry if you were in that kind of situation, about just another change in government policy? Because it seems like this whole thing is really swinging around pretty widely on sort of government policy in Washington and government policy in China.

Would I worry? Absolutely. I think you have to stay heavily engaged in government policy. So when you look at the type of investments being made in odd wood baskets and those kinds of things, I think it's reflective of some uncertainty about how long will I need this investment, is it going to be permanent, is it going to be for a while. I think we've got to see all of that play out. But back to what I said at the beginning, this fiber has to move to where the packaging has to be made for customers, and it will. It will find a way to move and the economics are going to be driven by the absolute cost of manufacturing and the nonmanufacturing cost of government policy.

Our next question will come from the line of Anthony Pettinari, Citigroup.

Regarding the Brazil packaging decision, I'm wondering if there's a time line for when that divestiture could be executed. Is there any read to your free sheet business in Brazil, which, I guess, has historically been very profitable? And then understanding that the packaging business has kind of underperformed since you acquired it, what sort of ultimately drove the decision that it might be better off with a different owner?

Anthony, I think that there's no specific time line because we're just starting the process and -- but we will provide updates as we have relevant information. We're going to look at several options. There are some creative options with that kind of business in that type of market, but we will move at a deliberate pace. And there's no read-through on the Paper business. The Paper business is structured entirely differently. In our IP words, we talk about trying to build an advantaged position, which has multiple dimensions. We have that in our Brazil Paper business, with our own land and eucalyptus fiber but also the cost structure and the ability to export probably the highest quality uncoated free sheet business -- product all over the world. The issue with the packaging business is it's a domestic business, and it depends on GDP growth. And unfortunately for us, we bought the business that we knew was going to need some additional work, but we bought it in the face of a deep, deep recession that I don't think anyone really anticipated. So with negative growth to basically 0 growth, we just haven't seen the growth we needed to get the momentum to be able to be competitive in that business. The box plant part of the business is very good. Our mill system needs work and we've chosen to deploy our cash in other places that have a much higher return versus in that Brazilian mill system. And had we had 4% growth, 3%, 4% growth, we might be in a different spot. But we've had now 3, almost 4 years of a contracted economy, which has greatly affected the box businesses. The business models that have worked in that part of the world are really similar to the business model we have here, which is an integrated business model for the local market and a very competitive export product for the rest of the world. We don't need that. We have all the export capacity we need out of the best place to make it, which is the U.S. So we're not trying to replicate that business model. And that's what led us to the decision, is that we have better uses for the cash and the depth of the recession in the local economy has just been more persistent than we had anticipated.

Okay, that's very helpful. And then just following up on Mark's question. You sell pulp into China, you have a lot of global consumer and industrial customers. Just wondering what impact you're seeing from these U.S.-China tariffs? Seems like year-to-date, the impact has been limited, but at least from some of the recent calls, it also seems like something that more companies are flagging and increasingly concerned about. Just wondering what you're seeing for IP and hearing from your customers?

It has been limited. We keep a very close eye on it. We're working our own channels of policy lobbying. The issue for us is that the type of products we sell, whether it's through our Global Cellulose Fibers business or even our Ilim joint venture, are products that the market really needs, and it's -- even with a potential tariff, is still the best option for the local producers. So unlike some of the people who've been flagging their supply chain with mechanical parts and other things that have reasonable alternatives with just a little bit of work, this is a natural resource business that the alternatives are known. And we have real competitive positions for the type of products, like the absorbent pulp or the softwood tissue and fiber that we sell out of our joint venture with Ilim, that really is the best solution for those markets. So we are watching it very closely, but that's really the reason for the limited impact.

Our next question will come from the line of Brian Maguire, Goldman Sachs.

Just wanted to ask on the Printing Papers business. I thought they were great results in the quarter and I think relative to your sort of guidance you laid out, they were also quite a bit better. I was just wondering if you could talk about what drove the upside to your expectations there and how much of that you view as sustainable versus anything that might be a little bit more transitory. And then just sort of tied to that, any concern that the stronger dollar might encourage some more imports like we've seen in the past? And just the last kind of tying it into the Papers business, last question, any thoughts on the timing of the conversion to white top kraftliner, any thoughts on, given the current economics, delaying that or pushing that out a little bit into the future?

Brian, it's Tim. Yes, I think you highlighted a great story in the quarter. Printing Papers across all of your regions performed very well and it was just like we said, it was across most facets of the business. Brazil had an exceptional quarter but even in North America and Europe, solid commercial and operational results. And I think that one of the aspects that's consistent across the regions is the ability for all of the businesses to sell more product closer to home, where they can secure better margins. In terms of Riverdale, we're still working through all of our detailed engineering and making progress. There's no update that we have in terms of timing. But we're looking at how we do it optimally for our businesses involved, both white paper business and the Industrial Packaging business. So no change, no update at this time, but we continue to work through all of our analysis.

And then just any color on imports, you might -- any change in what you're seeing there?

Yes, we haven't seen anything so far, so hard to predict the future. But yes, it's, we've had better opportunities, as I said, to sell more product closer to home in all of the regions, that includes North America. So we'll have to see how it plays out based on currency and other factors over the next few quarters.

Okay. And just sticking on the topic of imports and exports and shifting over maybe a little bit more toward the containerboard business. Just wondering if you're seeing any more competition in some of these export markets from other players, either existing guys or folks who are seeing a little bit more weakness in their domestic market and looking to move some stuff offshore? And tied to that, is the 4Q outlook that you laid out, does that include some slippage in export prices that we're sort of a picking up related to the tariffs and the currency shifts that we're seeing?

Yes, I mean, I wouldn't comment on price going forward. I think we laid out our expectations on the outlook, which would include also the export market. But we -- I mean, we've continued to see extremely strong demand across regions. I think in a seasonally low period, it's normal to see some spot business that pops up in different parts of the world, that's the way I would characterize it, and we'll see what happens as the season starts picking up, now that we're in the fourth quarter and different regions of the world.

Our next question will come from the line of Mark Weintraub, Seaport Global.

Wanted to just revisit a little bit some of the comments you made on pension. Obviously, it's been a huge use of cash, the contributions during the last 10, 15 years, and it sounded like you are of the view there's going to be little or no contributions, at least for the foreseeable future. Wanted to just understand your confidence level on that and how much you are systematically protected at this stage versus if interest rates move one way or another, the situation changes?

Yes, it's a great question, Mark. This is Tim. So I just want to say we were always partially hedged on interest rates and based on the improved funding level that we saw near the end of the quarter, we did increase that partial hedge to a higher amount. We can disclose all of that when we come back and remeasure in our, I guess it'd be in our fourth quarter call at the end of January. But we felt pretty good coming out of the third quarter. The pension risk transfer we thought was a very good move for us to make. And based on the improved funding level that we were experiencing at the end of the third quarter, that gave us the confidence to also make the shift on our asset allocation, to increase the fixed income exposure and take down equities.

And so at this point, is it -- do you feel that you are, under most scenarios, pretty well protected? Or is it again, is it kind of dependent on how things play out in various markets?

No, I think we feel like we've reduced risk greatly and that we're well protected. And of course, when we remeasure and we put out our annual number, we can share more details about that. But I think we feel pretty good right now.

Okay, great. And just to follow up, just to make sure I'm kind of understanding the thought process on share repurchase, on the one hand, you've described a systematic approach and then you also suggested it would be consistent cadence based on value. And so, I guess, I think systematic, that sort of typically wouldn't include too much of a weighting to where the stock might be trading at any given point in time, and yet that other comment of consistent cadence based on value, I guess, made me think that actually, you are going to be fairly conscious of where the stock might be trading as you make these decisions. How should I be bringing those 2 comments together?

Yes, it's a good question, Mark, and I think what we've said is we want to try to do both. We have not always purchased shares in a very consistent fashion over time. It's been very episodic, both in terms of timing and in terms of amount. And I think what we were talking about with systematic is we're going to be thoughtful about how we look at share repurchases versus other options for capital allocation, but we also always want to keep in mind our view of intrinsic value and buy below that. So yes, it's -- will it always line up? I'm not sure, but we want to have a posture where we are on a more regular basis are in the market buying our shares where we see value.

Our next question will come from the line of Scott Gaffner, Barclays Capital.

Tim, just going back to the dividend policy for a minute, I just want to clarify, because if I look at the dividend rate, it was about 40%, a little bit over 40% of the free cash flow last year, probably a similar amount this year with the growth in the business. Are we looking at 40% to 50% of the mid-cycle free cash flow generation, is that how we're thinking about the dividend policy on a go-forward basis?

Yes, we've pressure-tested it under a lot of different scenarios. But even under trough scenarios, what we're saying is we're committed to 40% to 50% of free cash flow on an ongoing basis. We want it to be sustainable. We think given our view of normalized and trough margin levels and cash flow, that we can return the current dividend at the $2 per share under most scenarios, most all scenarios, trough-tested and as well as normalized. So it's a view of returning free cash flow under any circumstance, except maybe something like we experienced in 2008. But we view it as sustainable throughout the cycle, up and down.

Okay. Yes, I hope nobody's planning for that type of recession again.

So do I.

When we look at the EBITDA margins in the North American Industrial Packaging business, they have expanded quite significantly this year. I think you said almost 24% in the quarter. I mean, how do you think about the sustainability of those margins on a go-forward basis? Because you did kind of get the added benefit of the price increase early in the year, and then as we talked about before, the OCC price dropping. Just how do you view the sustainability of those margins?

Well, if you look at our history, I think we've been within a fairly tight range through a lot of different macro factors. If you go back to '15 and '16, we were still in the 22% range. So I think over the past 5, 6, 7 years, we've demonstrated within a band our ability to manage our margins by the way we choose to participate in the various channels that we operate in, as well as the investments that we've made in our facilities to lower costs and improve supply chain capability. You're not immune from the market, but I think Mark alluded to it earlier and talked about our ability to manage through different types of circumstances, given our size and our capability. I totally agree with that.

So Scott, I'll just add to Tim's comment. I think you'll see, if you go back and look at recent history, you'll see our strongest margins tend to occur when the economy is the strongest, which also tends to be at the same time some of our costs, input costs are up and have pressure. And if you put all that together, there's a huge leverage on the demand side of the equation. So at a 2.9% or 3% GDP economy in North America, we have a business that's capable of generating in the margin range of 24%, in the mid-20s. When we have less than 1%, which we had just a couple of -- a few years ago, we had about 22% margins. And it follows logic in a way, based on the price cost relationship and what's happening in our customers' lives. When they're moving their product, we're there to serve for them, we have the flexible capacity, our margins tend to be a little higher. When the economy is slower, they tend to be a little lower. But from a results standpoint, we had strong results at 22% from a return basis and stronger results at 24%. But you also have the ability to look at the high and the low being a relatively narrow band now versus a long time ago, where there was a huge swing in margins based on economic outlook. So that's why we feel confident about the company we've built, and in particular, this part of the company that we've built.

Congrats on a strong quarter despite some headwinds.

And our final question for today comes from the line of Mark Connelly with Stephens.

Much of your white paper tonnage is outside of North America. Can you talk about how different the demand trends in those markets look to you from your vantage point?

Mark, it's Tim. Could you repeat that? I'm sorry, we missed the first part of your question, it cut out.

I'm just thinking about how much of your white paper business is outside the U.S. It's a heck of a lot and so I'm just curious, we tend to focus too much on what the U.S. market is doing. And I wonder if you could share with us your sort of global view of your different white paper markets and their outlook?

Yes, it varies region by region. Latin America has been very good for us. Brazil has been up and down, as you might expect from the economic performance in the country. Russia has been very stable and solid. We've actually not been able to meet all of the demand that we had in Western and Eastern Europe because of the fire that we had earlier in the year at Kwidzyn and the amount of capacity that we lost. So yes, there are secular trends everywhere to varying degrees, but there's also differences in usage that make some regions less susceptible, we think, over time to the types of secular decline that we've experienced here in North America. The usage here on a per capita basis, as you know, Mark, was extremely high in North America. The rest of the world never had those type of per capita use numbers, and so we see stable demand across most of the other regions that we operate in.

Okay, that's super helpful. And as long as we're on the topic of Russia, you've talked in the past about wanting to potentially expand your position in Ilim or certainly seeing Ilim itself expand. Are there any updates on capacity expansion or growth plans at Ilim?

Mark, this is Mark. We have a tremendous business over there and really good business partners, and we've said we'd like to continue to do more with Ilim because of its competitive position. And we are pursuing, as was previously discussed, Ilim's capital plan, normal capital plan, to expand our softwood pulp capacity. We also have a competitive kraftliner business there that's perfectly suited to serve certain specific needs in Asia, a narrower grade range, but an important grade range. And so it's a good business. There's obviously a geopolitical component to it. But on the ground with our employees, with our respective governments, the business has never really operated better, and it's got more growth potential.

Thank you. I'll now turn the call back over to Guillermo Gutierrez for closing comments.

Thank you again for joining our third quarter earnings call. As always, Michele and I will be available for follow-up questions. Have a great day.

Once again, we'd like to thank you for participating in today's International Paper Company Third Quarter Earnings Conference Call. You may now disconnect.