Graphic Packaging Holding Company (GPK) Earnings Call Transcript & Summary

Welcome back, everybody. Graphic Packaging is next. Probably will be a fairly quiet discussion. It hasn't really been a heck of a lot going on in boxboard the last couple of weeks, just kidding. Very happy that they're here today, Alex Ovshey, our old friend, we all know, who heads up FPA (sic) [ FP&A ] for the company is here; as well as Steve Scherger, the company's Chief Financial Officer and Executive Vice President. Steve has been in that role since 2014?

Yes.

And has been with the company since 2012. Prior to that, MeadWestvaco, and has a wealth of experience in the paperboard business. So we're glad you're here.

Thank you, George. It's good to be here.

So guys, what's new? Gosh.

Hardly anything, George...

We'll take questions then. Tell us a little bit about the news today. That would be a good start, perhaps?

Yes. Sure. A couple of things that we conveyed into the market this morning. One, we're very pleased to have entered into a transaction relationship with Greif to acquire the 7 folding carton facilities that comprise their Consumer Packaging business, a couple of hundred million dollars of top line. That's very consistent with our portfolio of food, beverage and other consumer packaging. They serve a lot of small and midsized customers, some customer overlap but not a lot, and geographically well-located facilities. So we're excited to be entering into that relationship. We would expect to close on it here at the end of March. And it's one that just, George, continues to fit our tuck-under acquisition, increased integration rate, drive integration through our packaging platform. It's very consistent with that. Consistent with the transaction from 30 days ago with the folks at Quad with the Omaha facility. It's a combination of -- it's about 125,000 tons of paperboard, about 90,000 tons of that is CRB, the rest is the CUK and SBS. So we'll...

How much did you say with CRB?

About 90,000 of the 125,000. And so we'll integrate in the CUK and SBS pretty quickly, upon close. And then overtime, the CRB will have a good supply arrangement and agreement with the team at Greif because we could not acquire the CRB mills is I know that you know. And so we'll have an ongoing relationship with Greif for those 3 mills in a supply agreement that we've established with them. But we're excited about it. We have line of sight, good, strong synergy capture, primarily -- as we said in our press release, we'll update our guidance for that acquisition upon the close, so probably at the end of the first quarter. And I think the EBITDA implications this year will be reasonably modest because there'll be some heavy lifting to integrate in the facilities and extract it out of Greif. But line of sight to $20 million of run rate EBITDA in 2021, and just very consistent, strategically for us. So that was the one thing that we brought into the market this morning. And in addition, and I'm sure we'll talk a little bit more about it, we also stepped back and took the opportunity coming out of the recent information relative to pricing in the open market for SBS and CRB. We stepped back and looked at what we're seeing in our business relative to commodity input cost inflation, and have factored in both of those into a reaffirmation of our full year EBITDA guidance of the $1.05 billion to $1.1 billion, with the $1.075 billion midpoint. We did that at a pretty granular level, as we now are experiencing both what that impact would be as well as what we're seeing in the market relative to commodity input costs.

Thanks for that, Steve. And forgive me, we've been running chock-a-block today. That tonnage that folding carton cut up, if you will, of converting, what will that do to your integration rate in aggregate?

Yes. The way to think about it is, over a multiyear basis, it's about a 300 basis point improvement in integration rates, at 130 -- 125,000, 130,000 tons. We'll probably get the first 100 basis points in the first year, the next 100 basis points over a couple of years. And then, with the long-term in mind, we'll get all 300 basis points. So we like it because it's just as we've talked, as a company, we're now, as we exited 2019, almost 68% integrated through the entire platform, with CRB and CUK being highly integrated at 80-plus. This continues to drive those integration rates higher. And we can see a path, along with what we did with Quad towards the low 70s being within line of sight here over the next couple of years.

And you may not be able to share much here. So I understand that in advance. But the off-take agreement with Greif, how -- could you share how it would be structured? And would there be a time expiry, where you wouldn't have that off-take?

Yes, it's a long-term agreement with them, but it's -- it has off-take opportunities to have the volume go down over time. And so I just would characterize it as they were providing about 90,000 tons to the business. We'll buy that initially. And then over time, we'll have the option to acquire fewer tons over the next several years, and it will step down at different points along the way. And that's on an as-needed basis, obviously, in terms of our own need to acquire tons externally relative to -- and of course, as you well know, this is, while it wasn't a part of it originally, just is in strong support of the investment that we're making in Kalamazoo.

Okay. Sure, sure. If you can comment further and to the extent possible, and again, that always being the caveat understandably around the recent change in some of the benchmark pricing for your paper grades. And again, the information source does a good job. So this is not direct at criticizing or what have you. But did you see that same level of drop off, if you can comment from January to February? Was this more, perhaps, from your vantage point a catch-up adjustment relative to whatever is in the market, again, not to be consistently to [ shore ] business?

Yes. No, let's just talk about that a little bit, and I'll try to hit on maybe several topics along the way, just in terms of kind of facts relative to our -- to the substrate, talk a little bit about actions that we're taking as well as maybe just a little bit about strategy. So I'll just try to touch on a few things there, given the nature of the importance of it. And I agree with you. Listen, the publication has a job to do. They've got a task. It's difficult. And they have to run the play that they've been running. So there wouldn't be anything ever disparaging around the work that's done there. But let's just kind of back up for a moment, just around the facts of the substrates. CUK, very strong backlog, a good, strong global substrate, one that we've got a real line of sight to, in support of our 100 to 200 basis points of net organic volume growth. And I think that speaks for itself as just a good, strong, growing global substrate with the right kind of characteristics to it, in support of the current pricing environment and our long-term commitment to having price offset commodity input cost inflation. If you stand back from CRB, there's been a lot of price movement in CRB over the last several years as we had to recover the realities of inflation through that business. We've successfully done that. And CRB is operating at 98%, 99% operating rate, so very high. Backlogs are consistent with history. And overall, the demand profile is quite steady. And so yes, I think on that one, was there are obviously something just on the edges, if you will, that resulted in the outcome on the suggested reduction. We don't participate in the spot market. We don't participate there. So our line of sight to that is not very high, just given how highly integrated we are. But overall, CRB, I think, to your point, that was likely more of a, if you will, a one-and-done or a look into and saying that of the $150 or $120 of it, if you will, is kind of clearly in, from their view. SBS, as you know, a larger market, 5 million-ton market. There has been more activity there as we've had some imports with -- from Europe, those have actually stabilized, they did not grow year-over-year in 2019, and don't necessarily see that they'll be growing in '20 based upon the suggested strategies of those that are -- are importing here. There is some capacity in the Northeast that is coming in at probably 100,000 tons or so a year. But the reduction in capacity that is playing out with one of the competitors has taken kind of now full hold. And I think one of the things you've seen with SBS, and we've talked quite a bit about it. SBS was operating in the low 90s. It really needs to be operating in the mid-90s in order for the supply-demand and operating rate environment to be conducive to offsetting commodity input cost inflation with pricing. We just saw, as the 95% operating rate, literally a week ago. Obviously, after that news, as that news was playing out with the $30. So I think there was probably a little bit of a timing challenge there that was playing out, given the inventory build associated with prior to a closure. We've been pretty consistent in believing that we wouldn't see mid-90 operating rates until we get well into the first quarter, and I think we're starting to see them. Because -- and so that's just a little bit of the fact base. And as such, if you talk about actions for us supply-demand, as you know, is absolutely critical, particularly given the large positions that we have in our markets. We have to be in an operating environment where we can offset pricing with where there is commodity input cost inflation, and that commitment remains in place. And so we'll have to stand back and consistently assess what are the actions that are necessary given what has been significant inflation through the SBS platform. The thing about it, though, and I know, like you said, there was a lot happening, and this all occurred last Friday. What didn't change last Friday is our commitment to Vision 2025. Our commitment to the 100 to 200 basis points of net organic volume growth that we see moving through the business this year. Our commitment to price offsetting commodity input cost inflation consistently over time, and that will play itself out here and next year as well to recover the $125 million that dislocated a couple of years ago. Our commitment to the tuck-under acquisitions. Our commitment to the execution of the capital that we're deploying that we can talk about here in a couple of moments as well as the balance sheet strength to move through the monetization of the international paper partnership. So none of that changed for us in terms of the things that we're focused on and in control of. So that's a long answer to your question, but I think it's important to put it into context relative to that. Now we factored the realities of that move into the guidance that we shared this morning.

So with the reaffirmation of the guidance, clearly, there's a little bit of a lag. So not that we necessarily know what you're planning for '21. But to offset this effect, if nothing else changed, there would have to be some additional productivity or other action from the company to maintain the trend. So we're a long way from '21, but what would you have us take away from that?

Yes. I think what I would do is if you kind of just try to be, again, be very specific, with the recognized pricing that we just were talking about, relative to 2020, there's about a $20 million impact on price this year. So our pricing guidance moved to $10 million to $20 million for the year. And right now, our line of sight into our commodity input cost inflation would indicate that overall, it's going to be pretty benign, probably $0 to $10 million. So both of those, we moved down, if you will, $20 million today, to keep us in line with the guidance that we provided and our commitment to doing so. To your point, yes, there's another $20 million of flow through to next year, but it's very early to talk about 2021 because our real commitment is to having price offset commodity input cost inflation in an environment that's conducive to do so, which would -- assuming that we see inflation come through the business would require attention and action on our part as we look through this year into next.

Makes sense. Thanks, Steve. Any questions from the audience on kind of recent news from graphic and/or regard to the box markets. If not, let's keep boarding...

There's one there.

Thanks. I didn't see it.

Oh, [ Ron ].

As long as it's on recent news, I'll go ahead and ask. In terms of these facilities from Greif, they've had an interesting history. And I'm just interested in your assessment of the assets themselves. I mean it's -- they've been -- facilities that perhaps were under-invested for some time. And how do they compare to what the rest of the footprint looks like?

Yes. Thanks, [ Ron ]. I appreciate you asking that. I think you said it well, these are well located, appropriately invested in facilities, but we will be stepping back and saying, how do those 7 facilities fit in our portfolio? And how do they best reside in our large footprint? And those are the kind of assessments we have a point of view of. And as we then take on ownership, we will be standing back and saying, well, then what does an optimized footprint look like that leverages our very well-capitalized infrastructure. Maybe some of these assets have unique positioning that can be more fully leveraged. And so as we do with all of our tuck-unders, we'll take a real hard look at what's the impact on the portfolio and how do we optimize and frankly, drive cost out. On a net basis, service our customers with excellence, and then, of course, integrate the paperboard in. And as I know you would know, there's -- the opportunity here is very substantial. The actual EBITDA more modest in terms of what's available. So I think the impact this year will be a little more modest because we're going to work through those things in terms of integrating this in, but we really like the potential that is here relative to this being a part of the portfolio, ability to drive that integration over time and optimize the footprint that's there among those 7 facilities into our broader converting footprint. Thanks, [ Ron ].

Yes. Thanks, [ Ron ]. I want to move a little bit to growth and some of the capital allocation decisions as well as the company is making. Let's take Kalamazoo first. Remind us again, why you felt that was the right capital decision? It's largely around cost, when so much of the sustainability growth is coming not in CRB but, I believe, in CUK?

Yes. And thank you for that. And we -- there are times where you have truly a unique opportunity to make a capital allocation decision that you can see very significant cost reduction opportunity that you're uniquely positioned to do it. And this is one of those because of our large position in CRB and the location of our facilities, and we reached a conclusion that we could, in fact, invest $600 million in our best capable machine and location and in Kalamazoo, structurally take out $100 million of costs, $70 million in fixed cost through the closure and elimination of couple of facilities and a pack -- and a machine and known advantages from a variable cost perspective, less energy, less water, less fiber utilization and create truly, long-term structural advantage in a market that we're committed to and in a market that is very highly integrated. And so there was a real opportunity here. And long term, 12% after-tax returns as an allocation of capital that has multi-decade potential advantage that is highly unlikely that others can do, given the structure of the industry and the location of assets, was compelling for us. And yes, we recognize it was a large scale investment, and we put it in the context of the growth that we'll talk about here in a moment. We have the balance sheet and the strength to do both, and to execute on the 100 to 200 basis points of net organic volume growth that we'll probably talk about next. But this was compelling for us, and it was also in our control. It didn't require growth and it was, and will be, capacity neutral. And those characteristics are quite unique and something that, for us, and we do -- and we looked at it intensely, as you can appreciate, we felt was a good use of investment capital in the business.

Will Kalamazoo, will K2 have ability to grow? If, in fact, you have the happy problem that the CRB market's growing a little bit more quickly than it is right now versus your expectations?

It does. And like any investment of this nature, we're putting very known and very capable technology in the ground. This is the furthest thing from a serial number one. So our confidence in our ability to execute on this is very high. But yes, we, of course, have the ability, as you know, through good productivity, good enhancements locally that if we are in an environment where CRB is a substrate that has a modest growth profile, that we will be able to meet those needs. We also have a footprint that we can leverage with other known facilities. However, that being said, that wasn't the assumption behind the investment but we have a lot of flexibility. We're very committed to the closures and to the reductions, as difficult as those are on the impact on people, they're the right thing to do for this, but we've got a lot of flexibility. And what we didn't build in to the business cases, we just described it to you, was growth. But we're looking forward to the customer engagement, the real customer dialogue around an absolutely best-in-class, highest quality, best environmental footprint facility that will be very unique in North America, certainly, in the world of CRB.

And George, maybe just to add to that. The investment is almost 100% driven by the opportunity to reduce costs. But I think as Steve was alluding to, I mean, there's an opportunity to create incremental demand for CRB by making it even more sustainable. And you take a grade that's already 100% recyclable, and you make it an even lower cost and lower consumption of energy and greenhouse gases. And that in itself could potentially over time, create that demand. We're pretty early on to our whole sustainability journey. And to the extent that that does play out, then we'll have the optionality to be able to meet that demand.

No, thanks for bringing that up because that is something that often gets lost in the -- simplistic, it's $600, and you're going to have some savings, but you're on a journey here with this -- both this machine and in terms of sustainability overall. One question that I had, typically paperboard. You talked a little bit about at your Analyst Day, paperboard will be typically more expensive than will be plastic in food service and probably most conversion opportunities. How much is that a limiting factor in terms of the growth you would otherwise be seeing? It seems like from some of the other companies, the conversion and sustainability train has already left the station. And so price is less of a factor. But maybe in food service, it's more of an issue. How would you have us understand that?

Yes. No, it's the right way to frame the question. And what we are so focused on is having products that are consumer-preferred that are also preferred in the eyes of that consumer relative to the sustainability advantages that also are preferred by our customers, the CPGs, in this case, also see it as functional, the right product, in support of their long-term commitments. And the one thing you won't see us do ever is kind of just assume that it's supposed to come our way. We have to earn it. We have to earn it with functionality. We've got to earn it because the product has functionality that functions well, that the consumer prefers and also, we have to address areas where the product isn't yet all the way to where it should be, and the cup is a good example of that with the resin that is inherent in a cup today. That needs to be addressed, so that we have more bio-based solutions, more recyclability, more renewability. And so we really, as you've seen us kind of pivot towards the opportunity of 100 to 200 basis points of net organic volume growth, with that comes the need for continued innovation and continued products that are fit for purpose, but also preferred. We know that at times, they'll be more expensive, which means they actually have to have a real preference. And we've seen that in cups, we've seen that in -- certainly in Europe with the beverage packaging conversions. In our line of sight over the -- certainly, the next 24 months is actually quite good on conversions of cups, conversions of plates, conversions of beverage packaging, particularly driven out of Europe with real decisions that we're now executing on. But there's no rest here. Because we live in a very competitive environment, other alternatives will continue to innovate as well. And so we know that that has to be earned over and over again.

Let's talk about the mile markers you thrown out. You have $130 million of revenue committed to in cups and bowls, I think $140 million in cottons and related machinery.

Yes.