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

Great. Good morning. My name is Arun Viswanathan. I'm the chemicals and packaging analyst here at RBC. So I appreciate you joining us for our Annual Global Industrials Conference. And delighted to have Stephen Scherger, Executive Vice President and Chief Financial Officer at Graphic Packaging, join us this morning. So welcome, Steve, and thanks for spending some time here with us.

Yes, Arun. Good to see you. Thanks for the opportunity to spend a little time with you.

Yes. We've got a number of attendees attending as well. So if anyone has any questions, feel free to type them into the list there, and we'll try to answer those questions for you. I do have a number of questions maybe we can get started with.

Sure.

And then we can cycle back to some others as well.

So yes, so first off, I guess, there's been a nice evolution at Graphic Packaging over the last several years. You had the partnership with International Paper, which now you've brought in-house and you've completed that ownership stake purchase. You've also started plans on a new mill. You've announced a number of acquisitions recently. So you do have your plate full of projects there, I'd say. So maybe we can just start with the new mill. Could you just give us an update on where you stand with that project in Kalamazoo? What do you expect to achieve out of it over the next couple of years? And anything else you'd highlight with that project?

No. It's a good place to start, Arun, and thank you for that because we're looking forward to it. As you know, we announced the investment a couple of years ago to build the world's -- which would be the lowest-cost, highest-quality CRB facility in certainly North America and potentially in the world. And so we're looking forward to it. We're on track to start up the facility in the fourth quarter. So we're looking forward to beginning to make coated recycled paperboard in Q4. And when we originally put the investment together, it was really a significant cost play, a quality play and certainly an ESG one as well, given relative to consumption of resources. And we have a lot of confidence in the project. As we said, it's been extremely well managed. The teams have done a great job of working through pretty difficult labor and supply environment. But we're on track and on time in terms of bringing it to life, a little more expensive just given some of the inflation that we talked through. But our confidence in the $100 million of EBITDA and nearing significant benefit is high. We'll see the first $50 million, we believe, in 2022; the second $50 million in 2023. And we're probably more excited about the investment even today than we were when we made the decision to do it, particularly given some of the good positive tailwinds from a sustainability perspective, some of the growth in applications that we've seen for CRB, specifically over the last couple of years. So high confident investment. It's a couple of years in the making. So we're looking forward to bringing it to life and really looking forward to it. And our customers are as well. As I was mentioning, significant reductions in water usage, greenhouse gas usage, et cetera. So it's also one that fits many of the ESG goals of our customers as well. And so it's kind of an excellent combination of financial benefits, ESG benefits, quality benefits as well as some unique characteristics that this Board will have that gives us high confidence in the financial returns.

Great. And I guess we can come back to some of the near-term cost pressures in a little bit. But maybe we can also just stick with the growth side. So you got the new mill. You've also recently announced a number of new acquisitions, Carton Craft, AR Packaging, which is much more substantial.

Yes.

Where are you on closing the AR deal? Are you still targeting Q4? And then maybe just remind us what that -- what you expect to add from an EBITDA standpoint on that acquisition as well?

Yes. Thanks, Arun. We are. We're excited about AR Packaging. You also mentioned the other acquisition, which has gone extremely well. We're integrating that nicely here in North America, and we'll get about half of the benefits from Americraft this year and the second half next year, obviously. But with AR Packaging, the regulatory approval process is well underway. It's going well based on all that we're experiencing. Obviously, those things aren't done until they're done. But we do expect to close here in Q4 as well, which is great because then we'll have the business in Graphic Packaging as we execute out of '21 and into '22. And as we talked when we had made the announcement, we expect about $160 million of incremental EBITDA that we've acquired that will endure benefits into 2022 and another $40 million of synergies over a couple of years as we optimize that business and integrate it into what will be the largest converting platform in Europe. We'll have a couple of billion dollars of converting business in markets that we know as well as some new markets, health care, pharmaceuticals, as examples. And Europe continues to lead the way from a sustainability perspective. We like the growth profile of our existing business in Europe, which is heavily beverage, consumer and convenience packaging-oriented. This business doesn't have much overlap at all from a customer perspective, which is good. Much more significant geographic reach, which gives us opportunities for growth. So we like both the opportunity to optimize and bring together our 2 businesses, but to also grow them from there with -- to it really both of our innovation engines coming together. So economic paybacks, we expect to be very good. It's certainly accretive in all ways. So as we look forward, and we're looking forward to having the team to join us. And like I said, we expect to close in Q4.

Great. And could you just discuss -- so with the increase in your converting capacity, what are your integration levels look like post-acquisition? Will you be sending more board over to Europe? And does that really help with global pricing within this market? What are your thoughts there?

Yes. Let's talk about integration rates for just a moment. We're operating now in the kind of low 70s, probably 71%, 72% integrated that's coming off of the something in the low to mid-60s once we did the relationship, completed the partnership with International Paper, which you brought on earlier in your remarks that we've since then secured full ownership of. And so we're kind of operating in the low 70s. And what we really like about the next couple of years with actions that we've already taken is that we've really got a nice line of sight into the low end of our Vision 2025 range, that kind of 80% to 90%. We can see our way towards the 80% range from a couple of things. One, a little bit of integration with AR Packaging, mostly on what was the CUK side. They were acquiring some equivalent board there, so there's a little bit of opportunity there. The recent Americraft acquisition, that's significant opportunity to integrate 100,000 tons of paperboard into our system. And then the organic growth profile, the actual 100 to 200 basis points of organic sales growth that enters integrated value as well. And then we have some existing supply agreements that will begin to unwind and we'll internalize that forward. So really all 4 of those accumulate into a nice path towards the low end of our Vision 2025 aspiration, probably early in -- probably late '22, '23 time horizon. We can see that path there. So all of the decisions that we've been making, the things we've been doing, obviously, we're looking to meet or exceed all of the Vision 2025 aspirations that we set out, but integration is certainly on track.

Great. And maybe we can just go back to the price/cost discussion.

Sure.

So most of our companies that we cover are unfortunately, seeing supply chain disruptions, higher raw material and input costs, potential inflation in freight and logistics as well. Are you seeing those as well? And what are some of the offsets you can implement to mitigate that impact on your business? Could you just discuss maybe the pricing as well and the pricing outlook?

Yes, no doubt. I think that certainly our business, like many that you just were referencing, industrial-like businesses, large raw material consumers, large uses of supply chains, inflation is real. And as we've talked about it in our last call, and as you've seen all of us continue to experience, we're keeping our customers in product and working tirelessly to make sure our supply chains are functioning effectively, but it's a challenging time. And so we are seeing inflation come through our business, much like is well chronicled, whether it's on the OCC side, whether it's logistics within our wood fiber applications or logistics, very well chronicled, resins in some cases, mostly for our cup and lid business. And so what we've been doing, and it's been very active for the last really 9 months, is to take price actions to offset the realities of the increases in commodity input cost inflation. And we've had a couple of years of modifications of a lot of the terms and conditions around the pricing, in terms of consolidating and reducing lags, taking other actions that we've made around freight and openers there, other things we've done around how we're pricing paperboard into the open market. And what that has done is given us confidence that price will offset commodity input cost inflation over modest periods of time, that any dislocation will be short-lived and addressed. And speaking specifically to that, our pricing initiatives, we talked about on the Q2 call, that we had line of sight this year to $130 million of price line of sight and clarity on another $270 million next year, so $400 million of known and recognized pricing, and we were pursuing about $550 million over a '21-'22 time horizon. Since that time, we've been successful in continuing to execute on some of the price initiatives. And based upon kind of the latest recognitions, we're in the probably $465 million price execution range over the '21-'22 time horizon, with $300-plus million of that coming in 2022. And we're pursuing another $200 million. We've announced additional price actions since Q2. We've got about $200 million of pricing that is in motion that we're looking to execute on in the marketplace, just given the realities of what you just described. And so that's a bit of an update on the $400 million is now roughly in $460 million, $465 million range in terms of what is known and will be executed on '21 to '22. And we're certainly in the market currently pursuing another couple of hundred million given the realities of, as you were just describing, supply chain disruptions as well as inflation across the full basket of our commodities.

And is there any visibility into specifics, or maybe -- obviously, many investors here focusing on OCC. They focus in on wood costs, chemicals. Is there any one area -- one or two areas that are particularly inflationary? And what would you say on OCC? I mean it's obviously very volatile and we come into -- getting in trouble forecasting it, but how do you kind of discuss the recovered paper market as well?

Yes. I think to your broader question, I think what is unique around this inflationary environment compared to others over the last probably decade is this is pretty pervasive. I think if you look across our -- what was it, $2.5 billion spend, if there's any -- they're all up. And I think specifically, OCC you touched on, has run pretty aggressively here certainly over the last 12 months to levels not seen. I think it's in the top 4 relative to the last 20 or 30 years in terms of where OCC is. And we certainly are not going to forecast where to from here. We'll just continue to take pricing actions necessary to offset those realities. What we have seen, there's plenty of virgin wood fiber available, but some of the logistics challenges kind of inner into the ability to extract trees out of the forest. And so we're seeing a little bit of inflation there. You touched on and you follow it closely, chemicals, resins, inflationary. Logistics continues to be inflationary. So given kind of the across-the-board nature of it, that's why we're so focused on taking the appropriate price actions as well as condensing and consolidating terms and conditions to recover it, because it isn't really a singular commodity. Actually, we're seeing it across almost the full basket of spend.

And I guess, just on a -- in addition to price cost, silver lining that some of the companies are mentioning is still robust demand. You mentioned the 1% to 2% organic growth. Is that still the right target? I know last year was a little bit better this year. Also, first half was better just given some greater at-home consumption levels. But what's the demand outlook? And are you still seeing the need to rationalize maybe a plant or 2 on the CRB side? Or is demand strong enough that you don't do those kinds of actions?

Yes. Just talking about demand, we continue to feel very good about the 100 to 200 basis point goal and aspiration that we've been executing against since we brought Vision 2025 to life in 2019. You're right, we've been operating a little bit better than that over the last probably 12 to 18 months kind of more in the 3% range. We're in the 3s. Year-to-date, growth is lumpy. We may see occasions where it's a little less or a little more like we've seen, but we like, in the short term, seeing the high end of that 100 to 200 basis points here in 2022. And our innovation engine, which our focus around plastic replacement, strength packaging, the cooking solutions, the $7.5-plus billion addressable market gives us confidence that we can consistently be in that 100 to 200 basis point range. We obviously internally aspire for more. And when we can get to a point where there's confidence that can be higher, we'll convey that. But we're sticking to that 100 to 200 basis points. Now is the right goals, both here in terms of the short to medium term as well as over the next several years. And it's really innovation-driven. We're going to see some of it, like you said, the vagaries of return to work and what is the kind of the future state of work. But in many ways, looking further down the road from a where we work perspective, they look some percentage of the working population being more home-based. And there is probably net value positive for us over time. And to your second question on CRB, we certainly can see the economic returns from the CRB investment from a cost takeout and shutdown perspective. But what we're thoughtful about it, if we see real demand that's sustainable demand, it could influence how we think about our facilities. But it will all be in the context of very deep rooted thoughtful demand recognition of our own demand and the supply, keeping those things in balance so that the pricing and the value that's created from the investment stays exceptionally high. But we've got -- what we really like about the platform we're building is outstanding optionality across all 3 paperboard substrates, both CRB, CUK and SBS. And you've seen us move product between and among them to meet customer needs and customer demand as well as to optimize our own economics.

Okay. Great. And thanks for the updates on the price side and what you expect to benefit from. But just to be clear, are you -- did you change your commodity cost inflation outlook? I think that was -- was it minus 130 for the year earlier that we said and -- but has there been any change to that post the storms or anything?

Yes, we're not updating any specific guidance today. I think what's important to note is, as we kind of have talked a lot, that when we see inflation coming in at levels higher than we would have anticipated or guided, we'll take more price action. And I think it's important to note, we've taken more price action. So we're obviously seeing more inflation. I think what's important is our confidence in the price/cost offset remains very high. You're seeing us be very assertive on the recovery mechanisms that we have in place, and we're looking forward to the price execution. And looking forward to 2022, as we kind of talked about on the last call, we really like the accumulation of what's possible from an EBITDA, particularly improvement scenario, as we bring on board AR Packaging as we get the second half benefits of Americraft. You've got a good $175 million of EBITDA growth there. We've got Kalamazoo coming on at $50-plus million of improvement. We'll have our own core baseline improvement of organic sales and productivity more than offsetting labor and benefits inflation battle in the $30 million to $50 million of value, and then we'll have positive price cost playing itself out. So it really does set up nicely for the kind of margin improvement that we're committed to getting on that path to the 18% to 20% EBITDA margins that are consistent with Vision 2025. It's really an important path to that, obviously, and those things accumulated to really marching forward positively on the margin improvement.

Great. Maybe we could also address cash. You guys have used a lot of cash for various uses over the last couple of years, including, again, buying back the -- buying in the IP stake, organic growth as well as acquisitions. So how do you prioritize cash use at this point as well as buybacks? So you've been active in several areas. Maybe you can just address those 4 buckets. What are you prioritizing at this point?

Sure. Absolutely. And it's the right question to ask. I mean as we talked, post the AR Packaging acquisition on a pro forma basis, we'll be levered up into the low 4s. And so one of our highest priorities as we thought will be to promptly move that back down closer to the 2.5 to 3x range that we have committed to as our desired leverage. And so we've set a target out of 3.5x by the end of 2022, being down towards 3x in '23. So that's a high priority for us, and we'll have the cash flow generation to do so, driven by a couple of things. Obviously, the EBITDA improvement of substance that we've been talking about starting here in '22 and CapEx is going to come down materially. We've put ourselves on a commitment to reduce CapEx from the $700 million to $750 million range this year as we finish up these investments back down towards $450 million next year. So cash flow generation in '22 and certainly into '23 will be very material, $600 million, $700 million. So we'll have the ability to drive the leverage ratio down materially towards 3.5x, and we keep that in mind towards 3. That being said, you'll know we'll be mindful of acquisitions or other ways to invest back into the company to create very clear value for shareholders. Dividend probably stays as is for the foreseeable future, I don't see anything changing there. And we'll continue to just be very thoughtful and value-oriented on any buybacks that we would do. We really do those as you've seen us do, and we clearly believe that the intrinsic value of the company is materially higher than where we're trading. So if that were to occur over the next couple of years, we would obviously have that as one of the tools we would use. But I think that debt reduction value creation is clear to us, and we'll be executing on that as we certainly work through what will be a higher leverage ratio that we'll be driving down here over the next 12 to 24 months.

And also just wanted to get your thoughts on the 3 major markets you play in. So CRB, it looks like, again, demand has been relatively robust. It's improved from sustainability and other dynamics. SBS, we've had some capacity additions, which have maybe resulted in a little bit different supply/demand balance. And then CUK I know is very tight. So -- and you're seeing conversion opportunities there. So how would you kind of describe the 3 substrates now from a supply/demand perspective? And what else would you highlight when you discuss that?

No. You did a nice job, Arun, of kind of summarizing it on the way in, but just to add a little bit of color to that. CRB, you're right, CRB, if you went historically, it was kind of a flat to maybe minus 1, even percentage market is a couple of million ton market here in the U.S., and we've got a large position in it, obviously. And there is a nice pivot there. There's some growth happening. The sustainability engine there is a positive, and we like where CRB is today. It's participating and stretching out to some of the truly just core traditional center of the store markets and playing a little wider. We've got involved in our strength packaging solutions, for example, in some instances. And so there's some nice opportunity there that we like. CUK, you're right, an excellent global substrate beverage growth, particularly driving that on a global basis. Europe, a big shift towards fiber-based solutions for cans, specifically and we'll probably move beyond that over the next several years. So there's a good global growth platform there, and we're investing behind that obviously. And then you touched on SBS. There's been a lot happening in SBS. It's a little more on the import front, but there's been closures as well and now demand has strengthened, particularly on the cup side and in certain cases on the coated side. So broadly speaking, whether it's backlogs, operating rates, inventory levels, all 3 substrates are in -- are well positioned. And that's important because when you're in an inflationary environment like we're in, you've got to have supply/demand dynamics that allow for the successful execution of pricing initiatives, which we are doing and are doing successfully. And so having all of those in a position where we can act when we need to from the realities of the inflation that we're experiencing, all 3 substrates are in that position today.

And would you say that there's been any change in competitive behavior just given those robust conditions? For example, on the containerboard side, we saw more machine conversions into containerboard from white paper when market conditions were very robust in containerboard. Is there any risk for anything like that in a recycled paperboard or some of your markets?

Yes. Obviously, we're always mindful of what could be conversions, as you said, in other markets where there have been. I think in CRB, it's unlikely that you would see anything because it's not a conversion into something unless someone making a URB converted into CRB, which is unlikely given the demand dynamics for URB, which are quite favorable. Obviously, there's other investments being made around the globe that have characteristics of a U.K. or an SBS or an FBB-type paperboard. So we're very mindful of them. But I think overall, it's one of the reasons that we continue to drive integration rates up so materially and we've got outstanding long-term relationships with our customers. And so you have to have a belief system that you could not only invest, but you could sell into these markets. So we're very mindful of it. We're very conscientious of it. We've looked at it globally when we look at the supply-demand dynamic. But I think overall, today, there's anything that is out there of relevance, certainly, that impacts the next several years from a supply/demand perspective in the 3 primary substrates.

And we've touched on sustainability a lot, but what are some of the initiatives there? I know if you want to tie in some of your new products as well, like the KeelClip and PaperSeal and whatnot. But anything else you'd highlight there? What are some recent wins or progress metrics you'd cite?

Yes. I think if you kind of just step back and talk about who we are as a company, Graphic Packaging, we've got a long history as a sustainable company, one that's been active in a circular economy for literally decades. And so when we think about the company as a fiber-based solution where we take virgin paperboard that we make the first time and then turn it 6 or 7x over into recycled paperboard in a very circular way and a very recyclable and renewable way. And so it's really at the core of who we are. And as we then look at how we've been able to invest in the company with our other initiatives to reduce our impact on the planet, Kalamazoo being a great example of that, other investments that we're making. We want to leave the planet in a better place and are certainly executing on reduction in greenhouse gases, reduction in water usage, reduction in other consumptions of energy, producing our own wherever we can. And so we really fit in terms of our aspirations and the realities of what is a do what's right for the planet. But broadly, ESG as well. I mean our commitment to a diverse and unique and then highly capable workforce and making sure that we're operating in the most inclusive way possible. Our Board takes that commitment extremely seriously relative to the makeup of our Board as well, being representative of the broader community of leadership. And so I think as you stand back from it, there's a really compelling conversation here to be had about who we are as a company and our commitment to it, and it's really at the core of who we are.

Okay. Great. Well, we're about out of time here for our 30 minutes. So I appreciate all the details, Steve. Again, you guys have a lot going on. So happy to hear the updates on the growth and price cost and sustainability as well here. So thanks, again, and good luck with the rest of the year, and we'll speak to you again soon. Thanks, Steve.

Yes. Arun, thanks so much. Thanks, everybody, for joining. Have a good rest of the conference. Take care.

Thank you.

Bye-bye.