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

Good morning. I am delighted to be back once again with Mike Doss, CEO of Graphic Packaging; and Steve Scherger, Chief Financial Officer. Graphic Packaging is a company that, from the outside, looks like it really hasn't skipped a beat or been affected at all by COVID despite some pretty obvious changes in what's actually going out there. But Mike, before we get started, I was hoping that you and Steve could just remind us how your careers have taken you to the job you're in right now.

Yes. Thank you for that, Mark. So I started with the company in 1990 right out of business school in the sales and marketing training program and progressed through a series of increasingly responsible roles. Moved into operations, ran a couple of our facilities, multiple plant responsibility assignments, was the general manager of our consumer packaging business for a long time which is our largest business unit headquartered divisionally up in New Hampshire. And then in 2012, moved to Atlanta, which is our corporate headquarters, became Chief Operating Officer, eventually President and then CEO from January of 2016. So I've been here, I'm celebrating my 30th year with the company and really excited about prospects going forward. I want to thank everybody for joining us this morning.

Yes. Thanks, Mike. Good morning, everybody. Steve Scherger. Like Mike, 25-plus year history in fiber-based packaging, financial background, but many of those years, as well like Mike, in more operational and commercial roles. Joined the team here at Graphic Packaging in 2012, led our consumer packaging business for a couple of years, and then migrated into the CFO role in 2015. So thanks, everybody, for taking the time this morning.

So I was hoping that we could take a step back for a minute. Graphic Packaging, leading fiber-based consumer packaging and food company that had really just turned the corners from a couple of difficult years with price cost, and then COVID hit. And really from the outside, if you weren't paying too close attention, it looks like you haven't really skipped a beat. So can we start by talking about the business lines, the significance of the great mix that you have, the importance of integration to strategy? And then let's dig into COVID after that.

Yes, sure. Steve, I'll take a shot at this, and you can add some color. But the thing that we've really been able to do over the last 5 years or so is build out our customer portfolio much differently than what the company was before. Specifically, we make center-of-the-store food packaging, we make beverage packaging, we make foodservice packaging, and we make consumer goods packaging. So when you think about all 4 of those verticals now, if one portion of it's down, the others tend to be up a little bit. And that really has allowed us through the pandemic to be able to take a pretty good body blow, as you're mentioning, Mark, around our foodservice business being down roughly 14% to 15% through the third quarter of this year, and make up for it because our food and beverage business has been up 6% to 7%, which is a bigger portion of it, roughly 77% of our overall volume. And so that's why on the surface, our -- we've been able to play and draw on our core volumes. And then the innovation that we've been driving on sustainable-based packaging, which I know we'll get into a little bit later, has allowed us to drive what essentially has been really solid growth this year, 3.5% organic volume growth even with foodservice being down as I mentioned. The other thing that we were able to do, and we did this when we bought IP's consumer packaging business in January of 2018, we acquired the third substrate that we did not have. So there are 3 principal substrates in folding carton consumer fiber-based packaging. We have all 3 of those substrates. We make all 3 of those substrates, and we're vertically integrated and then driving those paperboard production that we've got through our own converting operations. And what that gave us is a lot of flexibility. When foodservice went down, beverage was very strong. We're able to divert some of our CUK business into the SBS profile, keep that substrate very strong. The operating rates for our coated folding carton business is actually quite strong year-to-date. And you put that together, that allowed us to service customers, really meet consumer demand. And to your point, I appreciate you making the comment, we have been able to you kind of not miss a beat. Now the -- if you look at duck in the river, you never know how fast the legs are swimming, and certainly we've been swimming pretty fast with all that stuff. But what we like about the business model and the company we've built is the resiliency of that revenue base through a pandemic like what we've seen here this year. And that holds up really strong, and we think that differentiates us in a crowded market.

So let's talk about that big hit in foodservice because it really is sort of remarkable that you've been able to bounce from it. But foodservice was the fastest-growth business that you had before the pandemic happened. Do you see that growth coming back at the same sort of rate that we had once we have a vaccine in place? Or how are you thinking about preparing for that?

It's a great question. I don't know that we can speak with a huge amount of accuracy just how fast it comes back. But what I'll tell you this, is that with the announcements in the last couple of weeks about a vaccine from 2 different manufacturers, it would appear that sometime midyear next year that we'll be in a position where a lot of the American public and global public will be vaccinated. And that will create the new normal in terms of how people go out and want to eat again. I think the real question is what does that look like? Because there'll be different patterns. People will be working more from home even in a post pandemic world, we believe. And that creates some opportunities for us for take-home food. Conversely, that might pressure a little bit on our coffee cup business, where that has been a very strong growing business for us for the last few years as you well know. But what we believe is that our foodservice business will be a source of growth for us again in 2022. So we think 2021 will be repositioning, getting the business that we'll see some growth, we're getting back towards kind of where we were when we exited 2019. But we do expect it to be a source of growth again in 2022. It might just look a little different in terms of some of the products that we manufacture. But let's face it. I mean Americans like to go out and eat. They like to be on the go. And we would expect that we'd see that kind of activity again as the pandemic gets tamped down with vaccines and more effective treatment plans.

And Mark, just one thought there to kind of echo Mike's point around a gradual return to growth on the cup side. One of the things we really like about our cup business is it's very highly integrated. That's one of the things that's allowed us to weather through this environment is we're able to match supply and demand, both at the raw material level, the SBS, the one major line that produces the roughly 400,000 tons and our actual cup production. So when you're running a 80-plus percent integrated platform like we are, we're able to very tightly match the supply/demand needs. And we'll be able to do the same as volume returns to that business starting -- like Mike said, starting in '21 and certainly focused out into '22 and beyond.

So the rest of your business, the carton side has benefited on a net basis very substantially.

Yes.

More people shopping at supermarket, more people eating at home. How do you think about the puts and takes there? Because initially, there was a lot of concern about beverage demand dropping off. So can you walk us through sort of the pieces of the carton portfolio, and where you think some of that is sticky?

Yes. So within the carton portfolio if you think about it, 77% is food and beverage and then about 22% is foodservice. And we've got some consumer in that food and beverage number there, but it's a smaller portion of the total. So I'll just speak in kind of macro sense on that. The center of the store has been very strong for us through pandemic, and we would expect that to continue to be the case as we go into '21. That's what we're hearing from the customer set. They want us to be ready. They want us to be capable of supplying them because they believe that their demand is going to remain strong. On the beverage side, we've seen growth in both alcohol and nonalcoholic beverages. And we've seen shifts, and again to the innovation conversation, into products that require less plastic and use some of our paperboard. So there's a combination of growth that we're seeing there, both in terms of the increased demand for the off-premise consumption or at-home consumption as well as the innovation side. And we would expect those trends to continue into 2021. As we talked about on some of our calls in the past, if foodservice comes back, you would expect a gradual let off on some of the food and beverage side. But we would expect that core volume base, Mark, to remain very steady. And so the way we would ask investors to think about it is we believe our core volumes will be steady. And what we're going to be able to drive that 100 to 200 basis points of growth is all going to be around sustainability-driven innovation. And we've got 3 distinct platforms that we can talk about here when you're ready to do it around what we're driving in terms of growth, specific product lines that are of interest to customers and are resonating very well with the end-use consumer. So that's how we're thinking about the growth. We'll see some shifts in the portfolio based on how things play out with the pandemic, but what we don't expect is that our core volumes will go negative. We believe our core volume will remain flat, which it has today through the pandemic, and we'll drive the rest of that with innovation.

Well, it's been fascinating to watch the core volume strength through the pandemic. And so it's easier to imagine it's staying strong. But especially with the success that you have had with some of these sustainability initiatives. And that came -- that really got started long before the pandemic and started to show some growth before. So can you give us a sense where the sustainability initiative is going to have the most impact in your portfolio and maybe how that's changed with COVID?

Happy to do that. There's 3 main platforms that we're working off of. So it's around plastic replacement, it's around strength packaging, and it's around enhanced microwave packaging. And so if you think about the plastic replacement, it's a very focused effort for us. It tends to be on the beverage side of the business where we're doing things like KeelClips or -- which are replacing the Hi-Cone rings that you would see on the aluminum cans. We're having tremendous success along those lines. We've already placed over 20 machines in Europe, and we expect another wave of orders to come behind that as they get more into service and work across the system. The early reads from our customers on that on both the alcoholic and nonalcoholic, your customer set is very solid. It's around replacing foam with paper-based products, both clam shells and cups, and things along those lines that are very good. And we've also had some real success with this new product that we profiled on our third quarter called this PaperSeal product, which is a paper tray that we make paperboard for. It still has film on it, but what it allows the customer to do is merchandise it really well with high-end graphics. So think about proteins and cheeses and fish, where they can actually merchandise that material really well with graphics that we can print. And it still has a modified atmospheric packaging-type film over the top of it, but it separates really easy. So the end-use consumer can pull that plastic off, put the paperboard in the recycling bin. Any small amount of plastic then gets disposed into the garbage. And really good success in Europe and Australia on that. We've got a line that we're getting ready to launch in Canada. So North America, you're soon along those lines. So that's a nice profile of things that are really assignable. And we put resources behind that as opposed to trying to chase everything. And we think we can build competitive advantage on those kind of products really well. As containerboard continues to get more expensive, our solutions around paperboard become interesting and attractive to our customers as well, where they can keep the product in their own container and ship it in an e-commerce channel. We see certain verticals like pet food and some of the consumer goods items as being really good targets for that. So we're working along the lines there. And then an ongoing enhanced microwave packaging portfolio of products that really allows the consumer to have convenience and use products at home, this whole home cooking side of things. It's a business we've had for a long time, but it's gotten another resurgence here with COVID. So if you look at all that as we steer through into '21 and '22, our confidence level is high and we can drive 100 to 200 basis points of true organic growth on those kind of platforms.

Yes. I think Mark, one thing to add there from this time a year ago or year-ago September, when we brought Vision 2025 to life, a couple of points Mike was making. We actually believe the addressable market for our fiber-based solutions is larger than even we had expected this time 12, 14 months ago, which is good. And PaperSeal is a very good example of that. Moving into proteins, cheeses, other fresher categories is a good example of continuing to expand our market participation beyond even where we would have said this time a year ago.

It's interesting. As I just think about those categories that you listed, the enhanced microwave ability plus, et cetera, in most of those categories, you're not looking to just replace products that you're already selling to customers you're already selling, you're looking to take new business from somebody else or from someplace else. And so that as we do see these swings back hopefully towards something more normal, this doesn't really get caught up that much in that. This is looking outward to expand the pie. With -- sticking with that for a moment. We know that the compostable cup costs more. As we think about the sustainability initiatives, what do the economics look like for the customer? Are most of these products more expensive? How are customers thinking about the cost? And how long are customers going to be okay spending more where they have to here?

Steve, why don't you take a shot at that one?

Yes. I think what we've seen is that, yes, oftentimes, the product itself that we're producing versus the prior product is modestly more expensive. And so there is some premiumization that comes along with this from a cost perspective. In many ways though, the consumer has voted, the consumer has a preference and a bias towards the solution. I think our customers are recognizing that and are willing to make some level of investment to support it. And on a relative basis, on a relative basis relative to the overall cost of goods sold for that product, it's typically quite modest. So yes, it's higher value and has such higher consumer preference. Doesn't tend to be material relative to the overall cost of goods sold and giving the consumer an actual product that they prefer. So yes, it's relevant, but we're not finding our customers moving away from the realities of the consumer preference for the solutions relative to prior solutions.

Mark, maybe if I could add to that. I think the other thing that we're doing, if you look at the investments that we're making in Monroe and Sneek and even Kalamazoo, we're investing to make sure we're lowering our overall cost, so that we're able to provide the customer with these materials. But we recognize that we've got to be a cost-effective packaging supplier to them that earns the cost of capital, but still gives them good value. And so when you look at the investments we're making, we're trying to anticipate those things and position the corporation to be able to be responsive and successful over the next decade.

Well, it is fascinating to think about where some of the demand for these products are coming from. Sometimes it is coming from the customer who wants to improve their product. Sometimes it's coming from their distribution channels. The supermarkets themselves are saying, "You're going to change this package or we're not going to carry your product."

Right.

So for now, at least, we're certainly in a period where it's not as if there isn't a broad-based support for making these kinds of changes. So it certainly feels like sustainability and SIOC have some very broad-based support for them. You mentioned, Mike, you mentioned Europe and Canada. Can you talk about sort of the geography of sustainability initiatives as it exists now and as you see it over the next couple of years?

Yes. So without question, our experience has been that the sustainability trend started in Europe. And so having a good-sized business in Europe like we do, and 2 innovation centers in Europe tied to the ones we have here in North America as well as the one that we've got in the Asia Pacific region, allow us to move these trends around the globe, if you will, much faster. And so we're able to take those learnings and really apply them and get in front of what we see will eventually happen in the North American market. Usually, I'd say it's 18 to 24 months kind of in advance of what we would see here. And -- but it's really a critical strategy for us to be able to take those learnings and apply them back into our own operations here in a way that supports the customers. Because many of our customers, as you know, are operating in multiple geographies. And so even though one of their business units might have already adopted it, we still have to be in a position to have the capabilities to supply them around the globe. And that's something that we're able to provide as a large global supplier.

Are your customers -- I'm thinking about the complexity of the R&D and innovation process because some of it's pull, and some of it's push.

Yes.

How are you working with customers to figure out what you're going to be selling them in 2 or 3 years?

Well, these consumer insights that we get from our innovation centers really help us with that. So our commercial people are out talking to the customers all the time. They're bringing back those ideas. We have a cadence of monthly meetings that kind of roll up and put that all into a meeting that I attend actually as the CEO. We talk about major projects that are going on. We've got a stage gating process for how we're assigning resources to make sure that we're working the critical few that really have the ability to move needle and be responsive to our largest customers. We've actually made some changes within Graphic Packaging. And we're going to put innovation actually it's underneath me now. That's how strongly we feel that it's a key part of our growth strategy here going forward as part of our Vision 2025. And again, I think it speaks to the confidence that both Steve and I have in our ability to deliver this 100 to 200 basis points of growth. And as you say, it's about expanding the pie and then grabbing the biggest share of it that we can at Graphic. What we're not trying to do is just go grab share within the overall market. I mean there's going to be some of that, it happens from time to time, it's a competitive market. But what we're really trying to do is differentiate ourselves on these platforms with new products that actually win and provide the customer and the end-use consumer a new experience.

[Operator Instructions] But let's switch gears just a little bit here. A couple of years ago, you had so many capital projects and business changes going on that it was hard to keep track of all of them on one slide. Now a lot of those are behind you and there's just a few left. Can we talk about the projects that are done, what you accomplished, whether you're seeing the benefits you were looking for? But help us understand what those products were all about.

So I'll kind of frame them in some buckets here. So the one thing we did over the last 3 years is we've done 3 recovery boilers. And while no one gets really excited about that, it's work that has to be done if you're truly going to run safe, efficient and reliable mills. And so that works in our rearview mirror, and we're excited about that. And of course I have to say that, that actually sends a powerful message to the mill as well because they know that that's kind of lifeblood. That's the heart of the mill, is the recovery boiler. And if we're taking care of that, they know that the future of that mill is solid. And that buys us a lot of goodwill with our employees, and it motivates them to want to do a good job and want to drive improvement, which we need them to do. So that will be a bit of a tailwind for us going forward. You can expect about a $20 million pickup in EBITDA on the performance side of things here. Because we won't need to do that again for probably the next decade based on our reviews with factory -- and any of our virgin mills. So that's good, and we're glad we're done it, and we're glad it's in our rearview mirror. The investments we made on our beverage platform we've talked about, we had the big investment we made in Monroe, which is 7 miles away from our paperboard mill. We'll process over 300,000 tons of our own material there in 2021. Our timing on that couldn't have been better if you think about the beverage demand and how that's kind of played out. It's a highly automated facility. We're doing the same thing over in the Netherlands at our Sneek facility. They're commissioning that machine here that -- the new process, if you will, in our fourth quarter. So we'll be in a position to take advantage of that growth that we'll get in 2021 as well. So those were 2 big things that we did from a capital standpoint. We've also taken costs out of our mills by installing curtain coaters, which remove TiO2 and latex permanently from our COGS structure. So that eliminates future inflation up or down. We have 4 that we needed to do on our SUS machines. We've now done 3 of them, we've got 1 more to do. We'll probably do that in 2022. It's just a timing standpoint relative to the other things that we've got going on. They've worked. We've delivered the synergies on all of that. And the other big project that remains out there is the Kalamazoo mill that we're building. And that one will be operational in early 2022. It's on time, it's on budget. And we think our timing tiny again for having a low-cost, highest-quality recycled paperboard mill is excellent. I mean because the demand profile for that grade of paper is great. And we didn't justify it on growth. We justified it, as you know, on cost. And we're going to take out a number of our older mills and consolidate that volume into our Kalamazoo facility. So we're excited about that. And Steve, you can comment a little bit on the returns. Maybe with a little bit of the M&A too, and how we're thinking about that.