International Paper Co (IP) 2020 Q3 法說會逐字稿

Good morning, and thank you for standing by. Welcome to today's International Paper Third Quarter 2020 Earnings Day Conference Call. (Operator Instructions)

I'd now like to turn today's conference over to Guillermo Gutierrez, Vice President, Investor Relations.

Thank you, Maria. Good morning, and thank you for joining International Paper's Third Quarter 2020 Earnings Call. Our speakers this morning are Mark Sutton, Chairman and Chief Executive Officer; and Tim Nicholls, Senior Vice President and Chief Financial Officer.

There 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, including the impact of COVID-19.

We will also present certain non-U.S. GAAP financial information. A reconciliation of those figures to U.S. GAAP financial measures is available on our website. Our website also contains copies of the third quarter 2020 earnings press release and today's presentation slides.

Relative to the Ilim joint venture and 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 solid results and robust cash flows in a dynamic environment. We've generated $1.6 billion of free cash flow through the first 3 quarters as we continue to demonstrate the strength and resilience of our company. We're on track to generate $2 billion in free cash flow this year through our early actions and strong execution.

Relative to demand, recovery trends continue to vary by business and by end-user consumer segments. Demand for our corrugated packaging accelerated in the third quarter, and that momentum continues in the fourth quarter.

In fluff pulp, as expected, we experienced seasonally lower demand and destocking across most regions. In papers, we're in the early stages of recovery as offices and school activities begin to restart. Against this backdrop, our commercial, supply chain and manufacturing organizations are executing at a high level to ensure we meet our customers' changing needs, leveraging the scale and flexibility of our system and optimizing our costs. The company's solid performance in the third quarter reinforces our financial strength and commitment to our capital allocation framework.

Turning now to Slide 4, which shows our third quarter results. Operating earnings were $0.71 per share, which included an unfavorable Ilim foreign exchange noncash impact of $0.14 in the quarter. Sales improved sequentially and came ahead of our expectations, driven by strong demand in our North American packaging business. EBITDA increased by nearly $100 million sequentially, even as planned maintenance outage expenses stepped up by about $80 million.

As already mentioned, we generated robust free cash flow in the third quarter, which we continue to apply in a manner consistent with our capital allocation framework. During the third quarter, we reduced debt by about $800 million, bringing year-to-date debt reduction to $1.1 billion. Earlier this month, the Board of Directors approved the fourth quarter dividend, bringing the full year authorizations for our dividend to $800 million.

Moving to Slide 5. As I reflect on our performance this year, it reaffirms my admiration and appreciation for our 50,000 employees worldwide who continue to perform at a high level by taking care of each other and our customers. I'm especially great with our frontline teams in manufacturing and converting facilities around the world.

We remain absolutely committed to our COVID-19 principles, and we'll continue to focus on what we need to do to further strengthen the company for all of our stakeholders in the short term and in the long term. Now I'll turn it over to Tim, who will cover our business performance and our fourth quarter outlook. Tim?

Thank you, Mark. Good morning. Moving to the quarter-over-quarter earnings bridge on Slide 6. Third quarter operating earnings were better than we expected, driven by a strong commercial and operating performance as well as outstanding cost management. Higher volume contributed to improved fixed cost absorption in the quarter, which is captured in operations and costs. Third quarter performance also benefited from onetime items, which favorably impacted operations and costs.

Looking at the bridge, price to mix was essentially flat. Volume was favorable, driven by strong demand for corrugated packaging in North America and improved demand for Printing Papers across all regions. Operations and costs benefited from improved fixed cost absorption on higher volume.

The business continue -- the businesses continue to do an excellent job managing costs and delivered strong operational performance to mitigate the impact of hurricanes in the quarter. As mentioned earlier, onetime items contribute favorably to operations and costs, adding about $30 million or $0.06 per share, with each business seeing about $10 million in benefits.

As expected, maintenance outage costs were a drag in the third quarter, which is our highest planned maintenance outage quarter this year. I'll remind you that, in response to COVID-19, we made significant adjustments to the scope and timing of our maintenance outage plan. We now expect the full-year maintenance outage expense to be $450 million compared to $585 million in the original forecast that we shared with you at the beginning of the year.

Input costs were favorable, mostly due to lower-recovered fiber costs. We did experience higher energy and distribution costs as we exited the third quarter, which we see as a positive sign of an improving economy.

Corporate expenses were lower than expected, benefiting from about $20 million in foreign currency adjustments. Tax expense was lower by $0.07 per share in the third quarter, with an effective tax rate of 19% compared to 26% in the second quarter. Most of this was related to adjustments to our federal tax provision after finalizing our 2019 tax return.

Equity earnings includes a noncash foreign exchange loss of $0.14 in the third quarter for Ilim as compared to a $0.09 gain in the second quarter.

Turning to the segments and starting with Industrial Packaging on Slide 7. The business performed well, driven by strong commercial and operational performance. Across the segment, price and mix was stable. Volume improved sequentially across all regions with strong demand in North America where demand accelerated in the third quarter in just about every segment.

We're seeing the benefits of strong at-home consumption, and we're in the early stages of a recovery in foodservice. We continue to see very strong double-digit growth in e-commerce with increased consumer reliance on e-commerce as a buying channel.

More recently, we're seeing better performance for industrial and durable goods across a broad spectrum of the end-use segments, especially that is linked with construction and home improvement. Our export containerboard shipments were lower in the third quarter due to the strong demand in North America and the impact of weather events.

With that said, underlying demand in our export channels picked up as we entered the seasonally stronger fourth quarter. Our mills and converting facilities performed well. We managed direct and indirect cost well, while fixed cost absorption improved on higher volume, all of which helped mitigate the impact of precautionary downtime related to the hurricanes.

Maintenance outage costs were lower than expected as we descoped and shifted some outage activity to the fourth quarter to better support customer demand in the third quarter. Input costs were favorable, driven by lower recovered fiber costs. We did see higher energy and distribution costs as we exited the third quarter, along with a sharp increase in natural gas costs from the COVID-related lows as economies reopened.

Lastly, an update on Riverdale 15, the white top linerboard conversion. The ramp-up is progressing ahead of schedule and qualification activities are advancing rapidly through our box system. As a reminder, this investment benefits our box customers who value high-impact graphics and strengthens our containerboard offerings.

Moving to Slide 8, we've often talked about how we're investing to enhance our capabilities. And while that is often associated with investments we make in our mills and box systems, another important investment we're making is around innovation and enhancing customer-specific solutions. It comes back to the fundamental notion that boxes are tailored to meet each of our customer's unique needs.

We're accelerating innovation to further our advantages in faster-growing box segments. We developed eBOS, a software platform that enables our teams of experts to work with our e-commerce customers to determine the optimal design and suite of boxes to minimize packaging waste and reduce their freight costs.

For our Printing customers, we developed a recyclable moisture barrier that allows poultry, beef and pork boxes to compete -- to complete the fiber cycle. For our fresh produce customers, we provide a full-service machinery platform that's tailored to meet each customer's packaging needs. These are just a few examples of how we provide value to our customers to ensure they have the right box with the right support services for each particular application.

If we look at Slide 9, a quick update on the demand outlook for containerboard exports. Demand improved as we move through the third quarter, and customer inventories are currently normal to the low side. We're seeing an expected seasonal pick up in the Mediterranean region, with an especially robust citrus season in Northern Africa and a solid start in Spain.

We're also seeing a nice pick up in demand in China for industrial -- as industrial production recovers. And in Latin America, favorable weather conditions are supportive to continued solid demand for our banana and pineapple boxes. Our export containerboard channels provide good insight to box demand expectations across key regions, given a typical 60-day lead time.

If we turn to Global Cellulose Fibers on Slide 10, price to mix was favorable on price flow through. Volume was stable with a mix of about 75% fluff and specialty pulp. Operations and costs were impacted by unabsorbed fixed costs, which was partially offset by about $10 million of favorable onetime items, including higher seasonal electricity sales.

Maintenance outage costs increased as planned, and input costs increased on higher wood and energy costs. Taking a closer look at fluff pulp demand in the quarter, we experienced seasonally weaker demand and destocking across most regions. This follows a rather strong pull-forward in demand during the first half of the year. Overall, demand is stable going into the fourth quarter with improved fluff demand offset by weak demand for printing and writing grades. Tissue demand remains healthy.

If we turn to Slide 11 and look at Printing Papers, demand improved in just about every region from COVID restriction lows in the second quarter, but remain well below prior year levels. Across the segment, price and mix decreased primarily due to lower export pricing in Latin America and lower pricing in Europe. Volume improved across all regions, with year-over-year demand improving from about minus 30% in the second quarter to about minus 15% in the third quarter in our key regions.

Operations and costs benefited from improved fixed cost absorption as economic downtime decreased by 225,000 tons sequentially across all regions. We also benefited from about $10 million in onetime items, primarily related to COVID subsidies and green energy credits in Europe.

The business continues to generate meaningful cash flows by focusing on cost management and working capital. We exited the quarter with our inventories at our target range based on the current demand environment. As we think about recovery, we saw a meaningful improvement in demand in the third quarter. We know uncertainty remains while COVID restrictions persist. However, we do expect the recovery to accelerate as economies fully reopen.

Looking at the Ilim results on Slide 12. We had an equity loss of $33 million in the quarter. This includes a noncash foreign exchange loss on Ilim's U.S. dollar-denominated net debt, of which IP's after-tax portion was $55 million or $0.14 a share. Volume improved sequentially and year-over-year, driven by higher softwood pulp exports to China. However, price and mix decreased on lower pulp pricing. Operations were solid, and maintenance outages were well executed. The third quarter was Ilim's highest maintenance outage quarter in 2020.

Turning to Slide 13, we'll cover the outlook. We continue to operate in a dynamic environment with demand trends varying by business and end-use customer segments. As mentioned, demand for corrugated packaging accelerated in the third quarter, and that momentum continues in the fourth quarter. Demand for fluff pulp is normalizing following the inventory destocking which occurred in the third quarter. In Printing Papers we're seeing a modest recovery, although demand challenges persist.

Taking a closer look at Industrial Packaging. We expect price and mix to be stable. Volume is expected to decrease by $5 million, with strong box demand mostly offsetting the impact of 3 less shipping days in the fourth quarter. Operations and costs are expected to lower earnings by $15 million, including the non-repeat of onetime benefits in the third quarter. Staying with Industrial Packaging, maintenance outage expense is expected to decrease by $45 million, and input costs are expected to increase by $20 million, mostly due to higher energy and transportation costs.

In Cellulose Fibers, we expect price and mix to decrease by $5 million. Volume is expected to be stable. Operations and costs are expected to lower earnings by $20 million, which again includes the non-repeat of favorable items in the third quarter. Maintenance outage expense is expected to increase by $4 million, and input costs are expected to be stable.

Turning to Printing Papers. We expect price and mix to be stable. Volume is expected to improve $20 million on higher seasonal demand in Latin America. Operations and costs are expected to lower earnings by $25 million, mostly due to the non-repeat of onetime benefits in the third quarter and higher seasonal energy costs. Maintenance outage expense is expected to decrease by $16 million and input costs are expected to increase by $5 million. Lastly, under equity earnings, you will see our outlook for the Ilim joint venture.

Turning to Slide 14. As Mark said in his opening remarks, we're on track to generate $2 billion in free cash flow in 2020. In our first quarter earnings call, we highlighted the company's financial flexibility and some of the cash levers we had available to enhance our cash generation in what has been undoubtedly one of the most uncertain environments we've faced. Given the economic uncertainty at the time, we chose to pull some of these levers, including capital spending. In addition, COVID-19 changed the way we worked in 2020, and choices were made around our planned maintenance outages and other spending priorities, which we expect will contribute about 15% of our free cash flow this year. Our early actions and strong execution across the company are enabling us to deliver another year of strong free cash flow generation, reflecting the resilience of International Paper.

Turning to Slide 15, I want to take a moment to update you on our capital allocation choices in the third quarter. Debt repayment is a priority. During the third quarter, we reduced debt by nearly $800 million, which brings debt reduction to $1.1 billion through the third quarter.

We've essentially eliminated all bond maturities through the end of 2021 and improved our maturity profile over the next decade. I'd also note that we've reduced annual interest expense by nearly $60 million on debt reduction activity through the third quarter. You can expect additional debt reduction in the fourth quarter with an expected debt-to-EBITDA of around 3x at year-end on a Moody's basis.

Returning cash to shareholders is a meaningful part of our capital allocation framework. Our Board of Directors authorized the fourth quarter dividend earlier this month. With this decision, we will have returned about $800 million to shareholders through the fourth quarter.

Looking at investments, we're on track with our $800 million capital spending target in 2020, which includes the Riverdale conversion as well as other funding priorities to ensure we have the right capabilities in our U.S. box business.

With regard to our investment in Graphic Packaging, we received $250 million in cash in the third quarter related to the second transaction. This is the maximum amount permitted for each period under the agreement. Our ownership position is now approximately 14.8%.

And with that, I'll turn it back over to Mark.

Thank you, Tim, for all the detail. Look, this is our third earnings call under the realities of COVID-19. And as I've said from the outset, International Paper entered this crisis in a position of strength. It really starts with the talent and commitment of our employees. That strong position is reinforced by our capabilities to provide the best solutions for our customers and by our customers themselves. We are partnered with many of the winning customers in multiple segments across our 3 businesses.

And our strong position is supported by our world-class manufacturing and supply chain capabilities, all of which contributed once again to our solid performance and strong cash generation in the quarter. I'm pleased with our performance and really excited about our strong outlook for the fourth quarter, and the momentum we're generating, especially in our packaging business.

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

(Operator Instructions) Our first question comes from the line of Gabe Hajde of Wells Fargo Securities.

First question, Mark, has to do with the Global Cellulose Fibers business. And from my perspective, quite frankly, I don't think you guys are getting much credit for it. So I recognize that where you guys play, this is somewhat of a subsegment of a larger pulp complex. So I'm curious if there's something unique about kind of this cycle outside of the obvious COVID impact that we're seeing in printing tissue and towel that is negatively impacting kind of the supply/demand dynamics globally.

And then, relatedly, I think you guys made a management change here. And given Mr. Hamic's background, would seemingly imply more of the fixes might be commercial. But I'm curious if there's anything on the operational side that might be contemplated. We didn't see much in the way of footprint consolidation post-Weyerhaeuser.

No, those are 3 really good questions about our Global Cellulose Fibers business. First one, on the cycle, I think there's nothing unique about this particular cycle. If you think about '18, it was at the peak of pricing, the peak of demand. '19 was a somewhat normal reset. And then as we were turning the corner, in the beginning at '20, prices were moving up, volume was moving up, COVID hit. Temporarily, that was a benefit.

But now with the demand decline in Printing Papers, a certain amount of softwood pulp is stranded. So there's a supply issue that's unique to this cycle, but it's really COVID-related and it's related to the demand decline in Printing Papers. Some of that softwood pulp is finding its way into absorbent products at the margins, and that's creating, what I believe, is a temporary structural issue.

On the operations, I've talked before about what the business needs to be successful post the combination of IP and Weyerhaeuser, and that is moving the mix to about 85% absorbent products, so fluff and specialties; minimal position, but a small position in market pulp to balance the system. And then having the cost structure of the best mills, which tended to be some of the ones we acquired, be the cost structure of most of the mills. And some of that is going to take some investment. We've developed some of the projects, and now it's a matter of timing those investments. So improving the mix, improving the cost structure -- the manufacturing cost structure, and then operating commercially in an excellent way through the normal cyclicality.

As far as the management change, you mentioned Tom Hamick. His background suits what the business needs right now very well. He's had tremendous success commercially in different businesses in the company. And after we did the integration and we put the teams together, which was done very well, he does have the right skill set for where we're going forward. So we're excited about the role he'll play in that business.

And we believe in the business long term. We made this investment. If I take you back to the end of 2016, in order to position IP in another fiber-advantaged, growth-oriented market, albeit small market, it was a play for the longer term. And I think as you think about the demand drivers for diapers, adult incontinence and the other absorbent products, it's got good fundamental demand dynamics around the world. We have to level-set and improve our supply position, mainly in the ways that I described.

I'll try to be brief here with the follow-up as it relates to the Industrial Packaging segment. Obviously, demand has been somewhat episodic with the COVID impact. But I'm curious kind of if you can share anything on what you're hearing from your customers in terms of inventory levels. We're hearing that things are pretty well-depleted. And really, we're just seeing the benefits of sell-through right now. But just curious if you have any insight there.

It is, by segment, really, Gabe, a story by segment. And we are seeing some very positive trends in areas that were hurt a little bit. And part of it is, I think, inventory depletion. So the center -- processed foods center of the grocery store has picked up very nicely.

We talked a lot about e-commerce. That's up a lot, and it's staying up a lot. We began to see some improvement as restaurants opened. We have to see what that looks like as as we head into the fall and winter, predictable case load of COVID moving up and what different governments do to deal with that. But really encouraging news across the board sequentially. But even on the year-over-year basis, the e-commerce channel is an order of magnitude different than it has been. We think some of that will stay.

Our next question comes from the line of Anthony Pettinari of Citi.

You highlighted some of the investments for customer-tailored solutions for e-commerce and protein. I'm just wondering, from a big-picture perspective, if you can talk about the kind of returns you get from those investments. And then for the products themselves, if there's a margin differential or just how you get paid for those solutions when you're on the ground with a customer?

So on the examples that Tim shared are just a few examples of addressing the needs of our box customers, and then that flows back through our value chain, all the way to type of substrates and containerboard that we would make to make those boxes.

And if it's a capital investment, we're always looking at north of 20% returns. But some of them are not capital investments, they're design investments. And that's what we tried to highlight in this particular earnings call, that the talent level of our go-to-market strategy and our designers is coming up with unique products and unique services that can run on our equipment that we have, so the capital investment is small.

Where we see the payoff is 2 ways. Usually, there's a margin benefit if, in fact, it's a total cost of ownership, meaning it lowers the customer's cost; and two, it positions us in a differentiated way in a very competitive market to where we grow our position with a certain customer because we have an offering that's just enough different from the competitive set that it helps us to grow our position.

Okay, that's helpful. And then just sticking with Industrial Packaging, there's a containerboard price hike that's been announced. I'm just wondering, to the extent that you can, if you could talk about sort of the typical timing of price increases on boxes, how much, maybe using history as a guide, might show up in 4Q versus 1Q versus 2Q next year?

Yes. Anthony, its Tim. So we see it following a normal path. For us, we might pick up a little bit in the fourth quarter, but it's very minimal. Every contract is different. But most of our contracts allow for a 1 quarter lag, and so we start seeing the real benefits in the first quarter and then continuing on in the second, next year.

Our next question comes from the line of Mark Weintraub of Seaport Global.

(technical difficulty) packaging, obviously, demand really seems to be picking up a lot. If we could get your quarter-to-date box shipments, that would be helpful. And maybe even more importantly, what do you think is going on, assuming that you have seen some of this really strong pick up lately that we're hearing from others as well? And how sustainable is it?

Do you think folks are rebuilding inventories that got very low? And so to a certain extent, our -- what we saw before was understated? Or is it more potentially buyers getting ahead of the price increase? Any color you could give would be helpful.

Yes. Mark, its Tim. I don't think it's getting ahead of the price increase. People just don't warehouse boxes. They take up too much space. I think of something what Mark said earlier, there is some replenishing of supply chains that's going on. But there's also the continued opening of economies as well. And so we've seen pick ups in the third quarter. August was better than July. September was better than August. It's continuing in October.

Right now, nearing the end of the month, we're looking at about a 6% increase on a daily basis in our box system. But it's really strong e-commerce. That continues to grow. And I think that some of these other segments starting to come back. One thing that we see a little bit of a shift just on durable goods, it looks like people are substituting travel for durable goods purchases or maybe making other trade-offs like that. So we've seen an acceleration as we've come in from the third into the fourth. If you look at the market overall on a daily basis, the market is up a little bit over 1 point year-to-date. So in an upset condition, pretty good growth. And I think like Mark said, it'll vary by segment as we go through the fourth quarter and into next year.

Okay. Super. And just you made that comment that export market is looking strong and general demand picking up. And one area, China, you mentioned industrial getting a bit better. I guess one of the big questions is, how is China going to be dealing with their fiber issues with no OCC going in potentially next year? And as you look at it, could China become an increasingly important buyer of kraftliner from North America? And how important a factor could this be in the global equation?

Well, so we -- our base case is we take them at their word. And we think all imports of OCC will end, like they say it will. It will be a fiber-balanced equation, as you suggest. I think some of it will get satisfied by market pulp for certain end uses. And yes, I think there could be a step-up in not only kraftliner purchases, but probably recycled pulp purchases as well. That may take a little bit of time to fully play out. And as to where it comes from, I think it's going to come from a lot of different places.

I would just add, Mark, that the highest quality recovered fiber in the world comes from the U.S. market because of the high concentration of kraftliner boxes. And while China may not take any as OCC, it will probably take some of that feedstock as a version of recycled pulp or processed one time before it goes into China. And in the region, there are some people doing that. And I think there'll be some people doing that from the U.S. with high-quality recovered fiber, minimal cost input to clean it up, roll it, and then I think it probably qualifies as input fiber to China. But we'll see how that plays out. No one knows exactly how, but the simple math says that there's a tremendous fiber need for the growing Chinese economy that will have to come from somewhere.

Our next question comes from the line of Neel Kumar of Morgan Stanley.

With the Riverdale project, you mentioned the start-up being ahead of schedule. I was just wondering if you could just talk about your plans for ramping volume, particularly with a stronger near-term demand backdrop. And are you seeing any significant differences in the supply and demand dynamics of white top versus traditional linerboard?

I think, on Riverdale, we're really pleased with the ramp-up once we started up. So the ramp-up of the start-up is ahead of schedule. The project itself, obviously, was impacted in the final stages by trying to finish a large construction project during a pandemic, but it's running well. The quality is really, really good; in some cases, exceeding our design expectations.

And we will adjust that product, as we've said before, that white top liner, into our system in place of some lower-quality white top we were making, and then we'll just balance the brown and white. But we don't see any significant demand shifts right now and the need for white top other than the growth drivers we saw when we approved the project. So we're excited about it. It's going to help our box customers. It's going to help some of our open market customers who make their own boxes. Some of this product goes into the premium segments, premium wines, premium beverages. And there's a pretty strong demand for some of that. And probably, some of it's related to the way people are confined to home.

That's helpful. And then there's also an article recently about Amazon, again, looking to reduce the amount of packaging it uses and some shifting towards padded mailers rather than boxes. E-commerce demand has obviously been very strong this year. But I was curious if you were seeing any evidence of mailers taking share from boxes. And in general, how are you thinking about the efficiency of packaging in the e-commerce channel over time and the impact on these type of initiatives?

So we try to look at the solution that the customer needs, whether it's a box or a mailer. We try to obviously steer customers towards a sustainable choice, which is fiber-based, and we see growth in both. Mailers are used for certain type of items where it's the better solution. Maybe some of those items were in boxes before mailers became more effective. But we see growth in the box segment. We see growth in the mailer segment. We participate a bit on the kraft paper side of that.

And when Tim talked about this eBOS technology, we are proactively helping all of our e-commerce customers optimize their packaging suite. So the right-sized box -- if it's a box; and in many cases, a box is definitely the right solution given the supply chain it's got to travel through -- but if it's a piece of clothing, maybe a mailer works fine. But we are actively working proactively to get the waste down, to make the packaging experience for our customers cost effective, and for the consumer to know that they are doing something that's sustainable. If they recycle that box, and 92% of them are recycled, but that goes back in the stream, and it's just a good overall solution to commerce. And so we're actively involved in that, Neel, and view it as a positive, not a negative.

Our next question comes from the line of Adam Josephson of Keybanc.

Mark, just one question on the freesheet business. You took a good bit of downtime in your North American papers business this quarter as you did last quarter. If you assume that current demand levels stay roughly where they are, how much oversupply would you say you have? And after having just converted Riverdale, are you more inclined to potentially convert another paper machine to containerboard or to shut a machine if you eventually decide that you need to take more capacity actions in that business?

Adam, that's a lot of hypotheticals in terms -- we don't -- well, first of all, we don't think paper demand will stay at the level it's at. It will recover, probably not 100% of what the COVID impact did to it, but some of it will recover as schools and offices open to some degree more than they are now. You're right, we took Riverdale out not knowing that this was coming, but it actually was a benefit because it reduced our supply in the face of a real big demand decline.

I've said this before, and it will continue to be our guiding principle, on containerboard conversions, we'll only make investments in containerboard production, whether it's a conversion or a greenfield or anything else, based on the box and containerboard market. We won't do that based on the issues in another product line like uncoated freesheet in this question.

Sometimes the timing doesn't matchup perfectly, and you don't want to make a bad decision with an asset. But that's really what would drive it. So right now, we've got the ability -- we haven't done it in a while because we typically run uncoated freesheet relatively full -- but we have the ability to throttle that business with the same techniques we use in our containerboard business, so that we can adjust our output to the demand we have.

And obviously, if you never thought the demand was coming back, you would make some more permanent decisions than carrying the cost of economic downtime, as we call it. But we'll cross that bridge when we come to it. But what you need to know, though, is the principle for making more containerboard is about making more boxes, not about another asset that needs something to do.

Sure. And I appreciate that, Mark. And just one on the box business. So you have a slide in your presentation in which you compare economic indicators to box demand. Obviously, the tightest correlation is with nondurable industrial production. And as you know, CPG volumes this year have been extraordinary because of COVID. I think P&G had 16% U.S. sales growth, which is almost unheard of. And we've seen that all year.

So I'm just wondering, what you would extrapolate from this year's experience in terms of box demand, if anything? I mean obviously, consumers' behavior has been so unusual in so many ways that I find it hard to extrapolate much, if anything, into future years unless we continue to be stuck at home for years to come. What are you extrapolating into next year from this year's experience?

Well, a couple of things on the nondurables. I think correlation still holds. I believe box performance is outperforming nondurables because so much of the nondurable collection of market segments is not box intensive. So some of those nondurable items are actually down, and the box-intensive portions of nondurable goods is up a lot.

So I think the correlation is going to hold. I hope and I think we're not going to be locked in our homes. So some of this demand and channel movement will settle out. A couple of takeaways, though, just sitting here today. I do think we've been at this long enough, and some of our customers are saying this, that some consumer behavior changes will be pretty sticky. I think people are going to eat and go out a little different. So I think some of the demand and shifts in the food channel are going to stay with us, maybe not 100%. And then secondly, you have a lot of first-time new adopters to doing business in an e-commerce kind of way. And I think those people have had good experiences, largely.

And some of the retail channel we'll continue to be in an e-commerce kind of channel. And for us, for IP, given the investments we've made and the position we have, we believe that's a positive. The rest of it's tough to call. Probably, it settles out to something like we had before. But given this wasn't a 1-month or 2-month issue, I think behaviors and habits are beginning to change and they'll probably last a while.

Our next question comes from the line of George Staphos of Bank of America.

My first question was -- is kind of a tag on to Adam's question. What we've been trying to push companies on during earnings season so far is what change in behavior has occurred that will be sticky, to use your term, Mark, on a going-forward basis, specific to e-commerce because of COVID. And so I don't know that you're in a position at this juncture, 6 months into this, to determine what the incremental pickup might be from this changed behavior. But if you had any initial goalposts that your customers are sharing with you, or again, if you could affirm where you think this increase in demand will be most likely to stay at this new normal level, that would be great. And then I had a quick question on operations.

Well, as -- George, as Tim said, when you take everything into account, box demand in a bit of a crazy year, is up 1%. If the year wasn't so crazy, maybe the normal correlations are there and box demand is up about the same amount or 0.5% or 1.5%, the range we've seen in the last couple of years. I think if some of this e-commerce activity does remain, and we believe it will because of what I said about first adopters and people buying things they never bought before, that tends to drive some incremental purchases in some cases.

I think the big unknown is how fast, if ever, do people fully return to the way they spent money before and the things they spent money on: fuel, heavy travel, the service industry. That discretionary income tends to be now flowing into consuming goods, whether it's home improvement goods, luxury items or basic necessities of food and supplies for your home. And that is a much more box-intensive way to spend money from our perspective. And we believe that better level of that will continue well beyond when the all-clear is sounded.

Understood. We'll keep evaluating. You mentioned some of the things that you're investing in earlier in the presentation. Are there areas that you can share at this juncture, capabilities that you need to further invest in to continue to participate and lead in this new world relative to corrugated? Again, maybe it's additional print capability, maybe it's more -- I don't know how the small box initiative worked on e-commerce, but maybe it's more investments like that. Is there anything that you feel from a platform standpoint from -- and really more in converting that you need to invest in?

And then on the mill side, we've seen a dramatic drop-off in demand and then a dramatic resurgence in demand. You're not alone. Other companies have also pulled in some of their maintenance probably because you can't get people to facilities because of COVID. What are you doing now to make sure that, especially on the mill side, you keep the reliability, you avoid unplanned outages because this is a lot of stress on a very, very capital-intensive and important portion of your business?

So George, those are 2 great questions. Let me hit the investment opportunity. You basically said it, it's almost all in converting. It has a lot to do with small box and e-commerce configured plants that the physical profile of an e-commerce blank for a box is smaller. So most efficiently run on the right-sized machines. So we've actually evolved to a percentage of our several hundred box plants are becoming e-commerce-oriented plants. And they look different.

And if we ever build a new one from the ground up, which I think we probably will, it'll look different physically as well. Building size, and you'll have more of those located right near the fulfillment centers. And that's where our investment opportunity is. There's always an opportunity, and we continue to see it, to improve printing capability, and we're investing in that. And then sometimes, it's just pure capacity. We don't have enough box making capacity in a certain region of the country. And we have to add it organically or inorganically. And you've seen us do it both ways.

With respect to the investment question in the mills, we are blessed to have 16 containerboard mills, now 16.5, if you take half of Riverdale. We have a big system that's flexible. It is going to be wide open sometimes like 2018, and it will be less than that like it was in 2019. We're always going to try to keep that balance right. So we're going to look at it over a several year period and decide whether we have too much or not enough capacity. Investing in the reliability, you set aside the recycled mills, which don't have the complexity of a pulp mill and a power generation unit; those are pretty easy to manage your reliability spending. It's mostly about reliability in the paper machine, and we do that through largely noncapital investments.

On the integrated mills that take in wood, make their own energy and pulp the wood, that's where the big maintenance capital is and that's where the risk management is. So we have a hierarchy process where we -- when we cut back on maintenance, we don't cut back on the maintenance that could result in multiple days down. Usually, that's in power generation or in pulping. And so we would do that work and we would forgo some work that's in the paper machine area that even if it failed, our teams can get it back up and running with a repair, albeit maybe costly, but a repair within 24 hours or so. So that's how we approach that, so that we just have a risk management framework that doesn't leave our mills subject to major large outages.

Our next question comes from the line of Steve Chercover of D.A. Davidson.

It's similar to what Gabe led off with. So you guys used to talk a lot about industry structure and behavior in the context of containerboard. And I think the results demonstrate how important that is in generating good returns. And I would also think that the structure in fluff pulp or absorbent fibers is equally compelling. So when you hit your 85-15 target mix, do you think the returns in Cellulose will be similar to what you're doing in Industrial Packaging?

Steve, I think our goal is to get the Cellulose Fibers business to the cost of capital. But the Industrial Packaging business has probably got higher returns and probably always will. There's a couple of differences, though. The marketing in Industrial Packaging is a lot bigger. Fluff pulp is a smaller market. So it's residing in a very large pulp ecosystem of softwood market pulp, hardwood pulp, and then specialties at the top and pure commodities at the bottom. So it's got a lot of activity around it. So inside of that segment, the structure looks really good. But outside of the segment, there's a lot of activity. And that will play out over time.

But our goal is to get solidly to the cost of capital through a cycle that's part on our margin on the revenue and profit side on the top, and that's part on just reducing our cost. And then finally, the right mix, as you mentioned, on the 85-15. We see a path to getting it there. That will correspond to some level of EBITDA. There's opportunities for us to work on the footprint, as I think Gabe asked as well, and we have plans to do all of that.

Well, I thought that IP had evolved to the point where earning your cost of capital wasn't enough. You had to be generating in excess for it to be compelling.

Yes, that's correct. We believe the best value creation, if you look at S&P 500 companies that perform the best and have first quartile TSR, they tend to have a 200 basis point spread from their cost of capital. So we did that with the entire company. If you followed us for a while, International Paper as a whole, wasn't at its cost of capital. So the first goal is get it there, and then you build the spread, and we fully expect to be able to do that.

And by the way, we have a spread to our cost of capital in the entire company now, and that's our goal in each component of the company. But it won't be democratic and linear. There'll be some parts of the company that have a 5- or 10-year run well above cost of capital, and there'll be others that are right at cost of capital. But you've seen us take action on businesses and parts of businesses that we've concluded we don't think we're the right owner to get it there.

Sure. And then switching to containerboard, I was just wondering if you could quantify the financial impacts. And I know that they're already calibrated to the guidance, but how much of those hurricanes and that direct show in Iowa hurt you in the second quarter -- sorry, in Q3? How would you characterize your inventories? And finally, to follow-up on containerboard, are you -- would you say that you're growing faster than the market or are you still walking away from some suboptimal business?

Yes. So on inventories, we're pretty low at the moment. And I think we referenced that in some of the prepared remarks, just in terms of how we manage the channels during the quarter. Where we had to, we pulled back in some areas around export because we had such strong demand in North America. And now we've -- given the flexibility of the system and the ability to recover, we're on a better footing. And so we're increasing volume to the export channels in the fourth quarter, which is good because it's seasonally stronger anyway.

On the first part of your question, just in terms of the storms, through all of our operations and everything and being able to flex back and forth and move outages around, we feel like we offset most of the impact. So on a net-net basis, not much.

And the final question was, were you walking away for some business that's just not lucrative enough?

We always manage our mix. We don't talk about how we handle segments or customers, but yes, we're always trying to improve the quality of our mix across all of our businesses.

Our next question comes from the line of Mark Wilde of Bank of Montreal.

Mark, Tim, I wondered, could either of you just help us in kind of unbundling sort of what the activity in your box business has been by different markets this year? And in particular, I guess, how much that e-commerce business has grown for IP year-to-date?

Well, Mark, we don't give absolute numbers on that. But if you remember what I said last quarter, it was a cumbersome way to say it, but I think I said, orders of magnitude double-digit growth. So we were growing in double-digit percentages with a 1 in front of it before 2020, and we are significantly higher than that in growth. And that number or that range that I talked about in the second quarter -- on the second quarter call continues to be in the same range and a little bit stronger. So this is a significant uptick from, let's say, '19 and '18 and '17 where we were at double-digit levels, and it's just several times that.

Okay. And then just on supply in both containerboard and boxes, can you talk about how you're managing particularly that Newport, Indiana mill? Because I think I had heard that you might be shifting that out of containerboard and back to gypsum facing paper. And then also just where you're at on the box capacity. Because I'm getting some reports from people who say IP is so full right now that they're farming out business to independent converters.

Why don't I ask Tim to cover some of that detail. Yes, it's a pretty dynamic environment. Your memory is pretty good on Newport. So Tim, why don't you take us through that?

Yes. Thanks, Mark. Mark, Newport was a facility that produced not only white top liner, recycled white top liner, but also gypsum facing board. So if you remember, when we decided to make the investment in Riverdale, not only did we get a better sheet, a virgin sheet, better brightness, color and smoothness, but it frees up the Newport facility to, over time, be dedicated to the gypsum product fully. And we like that market. We really appreciate the customers we have in it, and we think it's good business for us.

On your question about the box business, we -- as you know, Mark, we provide containerboard primarily to our own box system, but also to the open market where we have long-term partners, whether they're making sheets and then feeding the sheet plant network. And so if that's what you're forming outcome makes, that's not new for us. We have partners in every type of channel that ultimately gets to a box. And I would say, all of those channels are very busy and very strong right now for us. So that may be what you're picking up, I'm not sure.

Okay. Last one for me, Mark, just to help us with modeling. As we think about this price increase, is it reasonable to assume that all your corrugated volume has some links to the Pulp & Paper Week indexes? And if not, what percent of the business might be on other mechanisms?

Yes. No, there's a big part of it, Mark, that is linked to our references. It's not direct, but references movement in the published price list or index. But we don't talk publicly about what those percentages are. We have a variety of customers where prices, it's set on a time increment basis. And contracts are written around those types of price mechanisms. So not 100%, it varies by customer and sometimes by segment as well.

Ladies and gentlemen, our last question comes from the last line of Mark Connelly of Stephens.

I'll try to keep these quick. You mentioned the higher wood and energy costs in the pulp segment. Was the wood cost mostly weather-related or was there something else there?

No. I think it was mostly weather, Mark.

Okay. Okay. And then just very last question. I'm just trying to do a little bit of math. In North America, did your containerboard system run full if you exclude the impacts you had with hurricanes and maintenance?

Yes. I mean we're -- like I said, inventories are on the low side right now. And we're working hard to cover our customer commitments, and we even pulled back and redirected from the export channel where we could. So yes, we're running as hard as we can right now.

And ladies and gentlemen, that was our final question. I'd like to turn the floor back over to Chairman and CEO, Mark Sutton, for closing remarks.

Thank you, operator. What I'd like to do just to wrap up, just, first, thank everyone for joining the call today. I really want to thank our employees, as I mentioned earlier, especially our frontline employees, who are showing up every day, taking care of themselves, each other and our customers.

I'm pleased with our performance in the third quarter, and I'm really excited about our strong outlook and the momentum that we're building as we finish up 2020 and we start to look into 2021.

So again, thank you for your interest in International Paper, and have a great day.

Thank you for participating in today's International Paper Third Quarter 2020 Earnings Day Call. You may now disconnect.