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Packaging Corporation of America Handles the Effects of Lighter Volume in the Third Quarter

Packaging Corporation of America (NYSE: PKG) saw lighter volume and weakened pricing power in the third quarter of 2019, yet the manufacturer of containerboard and corrugating medium admirably kept its profit margins intact. Shareholders weren't too displeased with lower revenue and profits, given the company's disciplined execution: Shares were down less than 2% at midday on Thursday following its earnings release before the markets opened.

As we discuss results of the last three months below, note that all comparative numbers are presented against the prior-year quarter.

Headline numbers from the third quarter

Metric Q3 2019 Q3 2018 Change (Decline) 
Revenue $1.75 billion $1.81 billion (3.3%)
Net income $179.8 million $206.7 million (13%)
Diluted earnings per share $1.89 $2.18 (13.3%)

Data source: Packaging Corporation of America. 

Essential details from the earnings report

  • Packaging segment sales declined by 3% to $1.49 billion. Corrugated product shipments rose 1.9% on a per-day basis. Containerboard production of 1,070,000 tons marked a decrease from the 1,087,000 tons produced in Q3 2018. Containerboard inventory at quarter-end declined by 51,000 tons.
  • In the paper segment, sales dipped 4.5% to $242.8 million. The division saw lower volume due to the discontinuation of paper production at the company's Wallula, Washington, mill in the prior year.
  • Despite the softness in volume, the company controlled its production expense. Gross margin slipped by just 100 basis points to 23.5%.
  • Similarly, management kept a lid on overhead expenditure levels during the quarter. Total selling, general, and administrative (SG&A) expense rose 2% to $137 million; as a result, operating margin declined by a reasonable 140 basis points to 15%.
A wall of shipping boxes stacked to resemble a Jenga puzzle.

Image source: Getty Images.

Earnings per share breakdown

Packaging Corp. provides an extremely useful breakdown of changes to earnings per share each quarter, which helps illuminate the major factors affecting earnings. When excluding special items, the company's third-quarter diluted EPS decreased by $0.31 against the prior-year quarter, to $1.92. 

The components of the decline include lower pricing and product mix of $0.36 in the packaging segment, and lower volume of $0.03 in both the packaging and paper segments. The company also cited the drag of higher converting costs of $0.06, higher operating costs of $0.02, and miscellaneous costs of $0.01.

Offsetting these headwinds, Packaging Corp. saw improved pricing and mix in the paper segment worth $0.09, and enjoyed the benefit of lower outage expenses of $0.09. Finally, the company benefited from $0.02 of lower freight and logistics costs.

Fourth-quarter expectations

Packaging Corp. doesn't present shareholders with an all-encompassing slate of earnings guidance numbers each quarter, preferring instead to outline the next quarter's bottom-line EPS expectation. In Thursday's earnings press release, CEO Mark Kowlzan discussed the outlook:

Looking ahead to the fourth quarter, in our Packaging segment we expect slightly lower prices as the remaining impact of the published domestic containerboard price decreases from earlier this year work through our system, and lower export prices. We also expect a seasonally less rich mix in corrugated products and slightly lower shipments with one less shipping day.

Containerboard sales volume will be lower as we continue to run to demand and work toward building some inventory prior to year-end in preparation for first-quarter 2020 scheduled maintenance outages at our three largest containerboard mills. In our Paper segment, volumes are expected to be seasonally lower along with lower average prices.

Kowlzan added that anticipated colder weather will translate to rising energy costs. Management anticipates other operating costs to climb against the fourth quarter of 2018, including converting costs as the company starts up its new box plant in Richland, Washington, during the quarter. Kowlzan also mentioned that scheduled outage costs will rise against the just-completed third quarter of 2019 due to scheduled maintenance.

Given the factors above, Packaging Corp. expects diluted EPS in the fourth quarter of 2019 to land at $1.70 per share, against a prior-year result of $2.17. While pricing power and volume have moderated this year as the global economy has moderated, Packaging Corp. has executed its shipment obligations with discipline, and it has expanded production capacity in anticipation of the next uptick in demand.

Thus, shareholders are likely fine with the company's reduced fourth-quarter outlook. While the stock was down nominally today, an investment in Packaging Corp. has provided investors with a total return of no less than 32% year to date.

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Asit Sharma has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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