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

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Good morning. Thanks for joining us today. Gabe Hajde here, Wells Fargo, securities research on paper and packaging. Happy to host our first presentation with Steve Scherger, Executive Vice President and Chief Financial Officer of Graphic Packaging. I believe Steve started in Graphic back in 2012, coming over from MeadWestvaco. And with that brief intro, we're glad you're here today. Looking forward to some dialogue on both Graphic as well as kind of current opportunities and challenges facing the industry.

So to start, I have a few questions that actually came in to me via e-mail prior to. So the first one kind of centers on volume growth and I appreciate you may not want to respond to this for competitive reasons. But is it possible that as we roll out to the beginning of next year and we learn that you picked up some incremental business by keeping either Battle Creek or Middletown, those mills up and running to capture growth versus shutting them down? And I guess there's a part 2 to that question but...

Yes. Well, good morning, Gabe, and thanks for taking the time, and thanks for those that are dialed in or listening in today as well. So appreciate the opportunity. One, with regards to the Kalamazoo investment, we're very pleased with how the progress continues to be very positive. The project itself, on time, on budget. As we mentioned, we expect to begin to make paperboard, the highest-quality, lowest-cost CRB, here in the fourth quarter and are well positioned to do so as we round the corner into 2022. As we talked about, the $100 million of EBITDA generation that we expect to come from that will come from cost reductions, both variable and fixed cost reductions, a couple of them through closures of facilities and then obviously the variable cost reductions as well, less energy, less water, et cetera. We'll obviously monitor the supply/demand and the volume environment for CRB as we work through 2022, but it's certainly our intent to continue to match supply and demand, ardent supply/demand for the product. We like the momentum of the business around CRB. We're seeing some growth and some participation beyond the traditional center of the stores. You've seen us in our innovation efforts. But our plans remain our plans for how we'll execute on the investment and certainly plan to see the first $50 million of improvement from that in 2022.

Okay. And then as it relates, I guess, to the -- your 1% to 2% and even telling us, "Hey, we'll be kind of towards the upper end of that range for 2021 in terms of organic growth," again, is it possible that we're having this discussion in February next year and that proves conservative? I mean I appreciate comps are a little bit difficult, and it's tough to tell. And we're talking a little bit before about reopening activity and sales to the grocery channel versus foodservice. But it seems like, at least now, we're hearing about backlog, 6 to 8 weeks. So maybe, again, is that possible it's a little bit conservative?

Well, it's absolutely possible. And as you've kind of seen us do, you go back to the end of '19, we put the 100 to 200 basis points out there. We felt very good about the addressable market for sustainability-supported paperboard-based growth. We're sitting -- coming off of last year. In the last 12 months, we've been at 3%, which is a good indicator of the engine, if you will, of innovation that we're executing on. We had a good first quarter at 2% coming off of 7% last year. So that gives us confidence for this year that we can be at the high end of the range, in the 2% range. And certainly, now that we believe the addressable market is larger broadly than what we had envisioned originally, now kind of in the $7.5 billion range, our confidence in the range is good. It's at the high end, and we'll continue to assess. We'd love to be able to convey that we think it's actually potentially higher. I'm not ready to do that yet. We want to let a little bit of the postpandemic environment play itself out, get the return to a little bit of the norm in the growth in foodservice, which we're seeing here in Q2, as we mentioned on the call, and momentum for at-home. Food and beverage consumption remains positive as -- through our innovation efforts that we've seen. So long term, love for it to be conservative. Right now, we'll stick with that range other than conveying that we see a clear path to the high end of it.

Okay. And then I guess on a longer-term basis, if I guess, kind of the plastic substitution turns into a multiyear, and it seems like it's very much in its embryonic phases, that, again, we kind of -- we learn that kind of carton board is, in fact, kind of that low single-digit consistent grower based on, again, conversations and dialogues that you guys are having today.

Yes. I mean that's what we're seeing. I mean there's a time and a place for all substrates, and we never argue for or against the right-suited purpose for any substrate. But what we really do like is the sustainability advantages, the recyclability characteristics of our paperboard solutions. The consumer has preference for them in certain applications. We've seen that, beverage packaging, a great example of that, as you know. We continue to see, as the foodservice comes back, cup conversions into paperboard, paper-based solutions. We really like the momentum of trays and bowls and other characteristics getting us into products like PaperSeal touching different product categories, so meats, cheeses, fruits, vegetables. Those are places we did not participate if you went back 4 or 5 years. And so we like that momentum as well because that's what broadens out the addressable market for us and has our participation strategies widening out, which gives us, again, that confidence in that low, consistent growth momentum that you were referencing.

Okay. And then the last one was on pricing. And so I guess the first part of it is based on some -- our conversations, at least, within the supply chain, it seems like CPGs are more focused, at the moment, on avoiding stock-outs and maintaining kind of the share of stomach that they, in fact, gained over the pandemic versus kind of pushing too hard back on price. And obviously, there are some customers where it's purely formulaic. But to the extent you can comment, can you remind us again what's embedded kind of in the guidance, number one? And number two, is it going through or do you envision it going through a little bit quicker this time around maybe than prior cycles? And then obviously, I guess, maybe the last part is, you guys have made some adjustments in some of your contracts as it relates to timing as well. Maybe just remind us what the differences are versus when we apply some of this -- kind of some inflation.

Sure. No, be glad to touch on all of that. As we came out of Q1 and obviously we have seen an acceleration on inflation and then bumped the range up a bit to kind of in that 4% to 5% inflation across our basket of commodities. And as such, we have taken numerous price actions, both in terms of announced published price increases and what's in the $90 million price guide, as we mentioned, is just the 2021 impact of known and recognized pricing with RISI being the primary benchmark. So only that which has been recognized, and that's what's in the $90 million. We're obviously in the market pursuing several other price actions, which we are executing on. And in total, over '21 and '22, that's a $200-plus million-type series of price actions, which are there intentionally to offset the inflationary environment that we're seeing. It is a -- as you indicated, pricing is more complex than just purely a market-based model and a publication that recognizes it. We have numerous initiatives going on, taking -- moving prices up with noncontract customers, for example, changing our freight openers to either having freight be the responsibility of our customer or having openers 4 times a year, conduct -- consolidating openings to where we're 2 times a year, 4 times a year so that on average, we're more in that 6-month time horizon for access to pricing because it's our absolute intent, as you well know, for pricing to offset commodity and input cost inflation and to have any dislocations that do occur to be shorter and shallower, and that's certainly our intent. As we are back in an inflationary environment, obviously you have to have a supply/demand environment that's receptive to those price actions and with backlogs, inventory levels at the levels we articulated with significant backlog, 6 to 8 weeks, inventory levels at historic lows relative to the cumulative impact of all 3 substrates, it's conducive to the need to take the price actions that we're executing on.

That's helpful. Thanks for the color there. And then I guess as it relates to -- a little bit back to the sustainability concept, but how does that play into the pricing decision-making or conversation, if you will, from your customers' perspective, whether it's kind of going -- changing formats or, in fact, a new product that they might be looking at?

Yes. Certainly, for existing products, our customers understand the inflationary environment, doesn't mean they enjoy taking on this inflation that's moving through certainly the commodity cost environment. But their understanding that "Listen, we've got movements in the cost structure, they need to be passed along and we're actively doing so." I think when it comes to new product development, which is where your point is, and it's a very good question, we're constantly making sure that the value of the product matches up with the perceived inherent value for our customers and the consumer. And so where there are premiums, if you're moving from one substrate to another or one product to another, it has to be value-oriented for our customer and as such, the consumers. So if you move from a traditional plastic ring to package a 6-pack of beer, for example, in cans, moving that to a KeelClip, there has to be an appropriate consumer preference for the product as well as the retailer preference for the product. And when those things come together, then the modest premium, on a relative basis, the modest premium for that product makes sense. And as such, we've seen the conversions to it.

Okay. That's super helpful. All right. Now on to, I guess, even outside of the pandemic, I think 2021, we can all agree, has already presented a myriad of challenges, raw material availability, logistics, winter storm Uri, et cetera. If there's anything, would you say there was one aspect of 2021 that's kind of caught the Graphic team off guard? And then what issue do you think kind of will take the longest to correct? More asking from an external perspective. I don't know if you've identified anything internally, and I'm thinking customer service levels or what have you. But -- and then really on logistics, your best guess as to kind of when that could improve.

Yes. Obviously, things that aren't in your control are the things you have to react to. And so was incredibly pleased with how our teams, once again, reacted to the shock of a major weather event in the South, particularly in Texas. And so it was disruptive, and our teams did a fantastic job of keeping our customers in product and keeping our mills running, once we were able to come out of the freeze, keeping them running effectively because the supply chain was disrupted. So getting access to chemicals and raw materials, it was expensive to do, but the right thing to do. It was in the $29 million impact that we talked about that was weather-related but can't be more pleased with how our teams reacted and kept our customers in product as well as our facilities running. I think what we are seeing, as inflation came through the business, is that the changes that we have made to our pricing mechanisms are working. Our ability to go from a price expectation at the beginning of the year that was in the $30 million range to one that is now in the $90s million speaks to the changes that we've made, the ability to move with the sense of urgency to recover inflation when it comes through the business. And so those kind of shocks to the system, whether it's weather, whether it's inflation, our ability to react, react quickly, proactively, now that's an important part of the value proposition for the business so that we don't have dislocations that are margin-eroding that take too long to recover. And so the test that this is on our pricing mechanisms is actually a good one, and we feel really good about how we're executing on it in short order.

Okay. And then I think earlier in the year, you kind of discussed 4 key objectives to kind of, I guess, yield what you would consider a successful year. I think one was to grow 1% to 2%; two was achieve your kind of targeted productivity savings, which I think I know the answer to that one; three was, again, we're talking a lot about price but to mitigate any inflation; and then four was kind of stay on task at Kalamazoo. Are -- do you feel like you're ahead on any of these items? And again, kind of the biggest challenges that you see to executing on those 4 key points.

Yes. And thanks, Gabe, for the 4-point reminder because it is -- those are the clear things for the year. And as we talked, on the good -- on the very positive front, 200 basis points of growth at the high end of the range, that's a positive. We feel good about that and feel positive on our ability to earn on it. Kalamazoo, we talked about earlier, feel very good about the investment in Kalamazoo, the time line for bringing that product to life and that world-class facility to life. So we feel very, very good about that. Price/cost, we're very pleased with our execution. We'll be a little bit price/cost negative this year, but full intent to recover over the '21, '22 time horizon with the price initiatives that we have in place. And so we'll have a shallow and relevant but short-lived dislocation there that will recover on a short time line. And then productivity, it's -- you can't control the weather. Unfortunately, that's going to cause us to be kind of at where we expected to be. We were actually targeting a very strong productivity year with the reduced downtime from recovery boilers that we've had to do over the last couple of years. We'll get to our number this year. We'll just get there in a different way because of the weather dislocation and disruption that we saw in Q1.

Got it. And then, again, kind of continuing on this disruption in the marketplace, there's -- obviously, some of your competitors have suffered from some unfortunate ransomware attacks and issues.

Yes.

I guess more specific to Graphic, how would you say you're performing from a customer service standpoint, on-time deliveries and things like that? And again, is it too soon to tell, like maybe you pick up some marginal business along the way? Or is it tough to differentiate between what's maybe new business wins versus stuff that was already in the funnel?

Yes. We didn't see anything that I would characterize as a temporary pickup associated with the very unfortunate ransomware environment that we all, every day, are actively working to keep bad actors out of our respective businesses. It is a constant battle for all of us, and we certainly are fully committed to continuing to do so. So I wouldn't point to anything there that I would characterize as anything that came our way. I think overall, customers, from an industry perspective, generally, we're a service. That being said, we're very, very busy. And with backlog being out and customers being in -- some customers being in an allocation-type environment, we're servicing customers very well, but it's a very tight supply chain. So every day, we've got to make sure we're keeping our customers in product, doing it effectively. There's not a lot of inventory in the system. So it's a tight environment. And as such, you're seeing the other actions we're taking relative to price, but we're servicing customers well, but it's not as if there's a plethora of inventory laying around in the system. And we've got to execute very well, every day, work hand-in-hand with our customers on their needs to the best visibility they have into their businesses so that we keep them in product.

Got it. And then I guess a debate right now amongst the investment community, I think, is just how quickly we, as consumers, kind of go back to prepandemic activity or behaviors, I guess. And so I guess the first thing that I would ask is for a base, again, whether it's anecdotal or just conversations, where do you guys kind of feel like CPGs are ending up in terms of if they think there's going to be a new kind of structural level of consumer demand through the grocery channel versus dining out?

Yes. Obviously, it's all playing itself out, as you rightly said. And I think that there are some changes in behavior that will, if you will, live on. And I think some of the consumption at home, entertainment at home, I think will have -- will live on as we've all adjusted, many consumers have adjusted their lifestyles in some ways where not everyone will return to the work environment they were in prior. And so I think some of the at-home work consumption will continue on. The acceleration in at-home delivery of food and beverages probably was a 5-year acceleration that happened in a year. And so behavioral patterns of having product delivered to the home definitely will live on. And as such, those products are packaged and need to be for delivery to the home. And so that -- I think that there is some benefit long term. We will return to outdoor activities and to stadiums and the like. It's happening as we speak. And so foodservice and on-the-go consumption should rebound. I think what's inherently positive about that is that the products, certainly for us, food, beverage, foodservice, consumer packaging that we do, generally are packaged products and have them be sustainability-oriented and viewed as good for you and good for the planet is where we spend our time, and that's where our new product development initiatives are focused. And so we like the natural momentum of the business, but to your good question, I think that some of the behavioral changes will have longer life to them, that it won't be just a complete reversion to the what was as we come out the other side of this and kind of get beyond this current pandemic, which we are doing.

I was curious too, when you talk about kind of revival on the foodservice side, do you see opportunities? I'm thinking of clamshell-type to-go packages or something like that. I mean I know there's conversion opportunity for sustainability reasons, maybe through your local deli or something. But really, as consumers maybe just pick stuff up and even thinking about Chipotlane, where they design their store for at-home consumption but you're picking it up along the way from wherever you're coming from. Is that an opportunity, do you think, for your products?

I think it is. And we're seeing some of that. And you -- Chipotle is a good example of a new clamshell for the new product that they brought. It's built for takeout, right? It's built to be removed from the facility and it can be consumed on-site, obviously. But I think a lot of the consumption patterns actually evolved to where there's more packaging that keeps the product warm or keeps it cold, allows it to be transported and done effectively, and that fits for us relative to our efforts, whether that be double-wall hot or cold cups that allow you to have a cup that's transportable from a store to the car, to home, same thing with clamshells, same thing with trays. Yes. So there's a lot of activity there that is good fit-for-purpose for us. We've got a lot of capability around that, as you know, to create the kind of products that are also branded where they need to be and that's important to our customers as well, certainly to the fast-casual environment or the at-home. So yes, I think you're absolutely right. And what's positive for us is that those are packaged products generally, and they are -- they need to functionally work, and that's certainly where we put a lot of our energy because the consumer experience needs to be equally as positive in terms of -- particularly when it comes to the quality of the food.

A couple of questions, I guess, on sustainability and somewhat from a different angle. I guess now that CPGs have had a couple of years, at least from our perspective, to complete some homework and research, maybe appoint certain personnel to certain positions and develop a more comprehensive plan, would you say that discussions are sort of more bilateral in terms of getting more sustainable packaging on the shelf and then kind of making a decision -- going down the decision tree, I should say, really, for specific applications? Because to your point, sometimes if something does, in fact, need a barrier property, a certain substrate may be more appropriate than others. So just curious on that.

Yes. I think if you look at how the consumer, if you will, has voted, meaning the consumer has a bias and a preference for products that are better for the planet broadly, I think -- and our CPGs, our customers have set very bold goals relative to their impact on the planet, I think our customers recognize that they can't do that alone, that they've got to do that with their suppliers. And as such, when it comes to big goals around whether it's water reduction, energy reduction, doing it with someone and being able to point to the positive implications of how product is produced really flows through the whole supply chain, and we play a role in that supply chain. And I think that's quite relevant, and we see that in our conversations with our customers because they're saying to us, tell us about your sustainability footprint, tell us about your goals, your ESG goals, what it is that you're aspiring to do and how those can help support our goals in terms of what we're aspiring to do as a customer of ours. So it's actually -- the supply chain is becoming more linked together in a positive way relative to the net impact on the planet and on the environment broadly.

All right. And then one from, I guess, the -- an investor perspective, that as some of these ESG funds and/or investors become more sophisticated, what topics do you find yourself most engaged with when you're having dialogue with them? Meaning, do they kind of come to you with a preconceived notion as to what they think an advantaged substrate might be and then dig deeper on the social and governance aspects? And then if you're able to, you guys put out a pretty comprehensive sustainability report. Is there any one area, maybe your scope 1 environmental impact or something, where you feel like you're ahead of the curve a little bit, and that gives you an advantage, either access to customers or capital or anything else?

Great question, by the way. And one, we feel very good about the latest overall reporting, sustainability reporting. We'll continue to invest behind that and enhance it. And what we're seeing, certainly from an investor perspective, is that what kind of started as a more singular discussion around sustainability or around the environment is actually quickly and appropriately evolving into a bigger discussion. So an overall discussion around not just our environmental footprint, our commitments around sustainability, but our commitments around how we govern the company, our commitments around diversity and inclusion and all things equity-related. And so actually, we're finding the conversations like we're having with you, like you and I are having right now, to be wider-ranging, as they should be, around the how and how we lead and operate and run the business, with our employees in mind, with our stakeholders in mind, with the broader implications of our responsibilities to our communities and to the environment and to our people. And so actually, how that's evolving is in a good positive way. Obviously, we're held accountable for the financial metrics, but the how you get there and how you get there along the way in a more inclusive set of definitions around ESG, I'm finding to be favorable as we all evolve these conversations.

Well, that's good. I mean it's a tough environment. I, quite frankly, don't envy your position in terms of not merging the political and a lot of these things where some companies are either interjecting themselves or feel the need to get involved. I guess just the last question on productivity. You guys have done a really nice job over the years in delivering productivity. Do you still feel like you still have a pretty healthy pipeline going forward outside of the Kalamazoo project?

Yes, we do. And as we've talked before, we're in a bit of a constant 5-year capital planning cycle for us at the broadest level, and we're in about a 3-year cycle at a detailed level. And as we look out over the next 3 to 5, I like the productivity initiatives that are out there. There are more of the kind of things you've heard us talk about in the past, the next round of curtain coaters or the next round of converting investments that make sense to do like we've done in our Sneek facility in the Netherlands, like we're doing -- like we did in Monroe, like we're doing to take out TIO2 or other costs, like we're doing around automation. In our last 30 seconds, I mean, the labor pool, as we know, is very challenged when it comes to entry-level, lower-skilled roles. And so a lot of capital investments around how do we automate lower-skilled roles, bring more technology to bear to drive productivity in what is a challenging labor environment for those skills. So those are the kind of combinations of what you'd see. And we like the road map for the next 3 to 5 years.

Great. Well, thank you again for the time. I hope this is helpful for folks, and we'll talk to you again next quarter.

That's great, Gabe. Thanks so much. Thanks, everybody who dialed in and listened and appreciate it. Thanks for the opportunity.