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

Good morning and welcome to Citi's 2021 Basic Materials Conference. I'm Anthony Pettinari, packaging analyst here at Citi, and we're very pleased to host Steve Scherger, CFO of Graphic Packaging. I think we're going to jump right into our discussion. For those on the line, you can submit questions to me through the portal or just e-mail me directly, also if you need any disclosures.

So Steve, thank you for joining us. Maybe we can start off with price cost as you kind of exit the year and think about '22. It seems to be kind of the big topic for the packagers that we've spoken with yesterday and today. Can you kind of remind us, as part of the recent earnings, your guidance around pricing actions and commodity cost inflation. And then just kind of the confidence that the price actions that you've realized that have been reflected in Pulp and Paper Week are going to stick over the next 12 months?

Yes, and good morning, everybody. Good afternoon for those joining from other places. I'm thrilled to have the opportunity to spend some time with you, as always, and so Anthony, thanks for that. Yes, relative to the pricing environment and the price cost relationship, you touched on it very well. We've been very assertive in taking multiple price actions really throughout the year, resulting in roughly $250 a ton of price improvement across all 3 of our substrates along with the models that we have for passing cost inflation through our -- to our customers. And so -- as you've seen in our disclosures to date, we have about $650 million of pricing that we will execute on in the '21, '22 time horizon, about $140 million of that this year and a little over $500 million of that next year. And to your point around confidence, we're highly confident in that. It's all contractual. Our customers know of it. It's in our contractual relationships with them and we'll be passing those price increases along to them. We have been and will continue to, and obviously, the majority of that nearing benefit in 2022. And so very high confidence in our ability to execute on it. We've been building out our model over the last couple of years to be in a position where we can effectively pass pricing along when we see inflation moving through the business. You're correct on the inflation front, a little over $300 million this year. And so we're in a price/cost negative environment this year that we've disclosed and shared, which will turn positive next year, and it's important. It's an important part of the price offsetting commodity input cost inflation commitment that we have, and we're well prepared for where inflation goes next year. Obviously, we don't know exactly where it will go, but we will recover at a minimum the $170 million of price cost dislocation from this year, and we've shared that in our conversations around the $1.4 billion plus of EBITDA next year that we can talk about here as well. Obviously, on inflation, we're seeing some abating of some things. OCC and some resins have kind of stabilized a bit. Others -- other costs continue to move up and you're seeing that, obviously, volatility in things like nat gas. But overall, our confidence in price, more than offsetting commodity input cost inflation and this dislocation we're experiencing this year into next year remains very, very high. There's a little bit of pricing out there that we've announced that's not in the $650 million. There's another $50 primarily on the SBS grades that will be opined upon and that we're executing on late this year that could have some positive benefit in addition into next year.

Great. Great. That's extremely helpful. On a quarterly basis, is there a way to think about when you would achieve price/cost neutrality based on the guidance that you've given?

Yes. As we kind of stand back from it, and we're working through obviously a fair number of our negotiations for next year around some of the commodities that we buy. But here in Q4, we'll continue to be modestly negative as based upon the inflation that we're absorbing here in Q4 and the pricing that's rolling in. But because there's a very significant amount of pricing that rolls in very effectively early 2022, I would expect we'll be more towards that neutral to modestly positive in Q1 and then much of the offsetting of this year's $170 million will be value created in Q2 and 3 and 4 of next year.

Got it. Got it. And in terms of the overall confidence in price increases sticking, I mean I can remember some previous years where Pulp and Paper Week realized boxboard prices and then those got rolled back several months later and why they got rolled back was sometimes a little bit of a head scratcher. I'm just curious if you could talk about maybe what's changed either from a GPK perspective or an industry perspective or just maybe the demand environment that gives you that confidence given the Pulp and Paper Week pricing mechanism has been a little hard for some of us to follow from the outside.

Yes, I think you have to take really a multiyear view of that. If you look at what we've been executing on over the last really almost 5 years, certainly from an industry structure perspective, the structure of the industry is in a different place than it would have been in the time horizon that you were articulating there. And so that certainly is relevant because it's impactful relative to the supply-demand environment. And I think what is we certainly have confidence in is that we're in an environment that the demand for our products is supportive of that 100 to 200 basis points of organic growth, and so we're in a net growing environment. Overall, supply is consistent with that demand. And so -- and that shows up in operating rates, backlogs, inventory levels that are very conducive to the appropriate need to pass pricing through in this inflationary environment. And we've also taken numerous actions over the last several years as we've talked, reduced time lines, changed terms and conditions, passed cost through in a more meaningful way on things that have less controllability like freight, for example, moving that through to our customers as an example of term changes that we're making. And we've changed the nature of how we do so. A little bit of that open market -- paperboard into the open market. Those terms and conditions have changed quite materially as well with our open market customers, which is what an organization like RISI actually is opining on. So I think you really have to take a multiyear structural view of this, which is why we're able to speak with confidence that we expect the pricing to contractually move through and to be maintained at this level or above, depending upon what we continue to see on the inflationary environment.

Got it. Got it. And you talked about, I think, the $50 a ton in SBS that's still outstanding or hasn't been realized in Pulp and Paper Week yet. Can you differentiate between the 3 grades that you produce in terms of the relative strength this year? Prices for all 3 have been going up, but I'm just wondering if you could kind of walk us through the 3 grades and sort of the dynamics that you're seeing.

Yes. I think on the positive front and really consistent with what we were just talking about, all 3, you have very positive attributes if you stand back. And we're really pleased with the demand for CRB recycled paperboard, just broadly. The demand there has been excellent and consistent with and actually probably has exceeded the expectations we had a few years ago. For example, when we made the Kalamazoo investment decision, I think we're more favorable today on the demand for CRB than we were even back when we took the decision, as an example. So demand for CRB, very good; inventory levels, very low; backlogs at historic highs. CUK has a long history of a strong demand profile, and that has really continued with a global demand profile for CUK. Our shipments into Europe and around the world continue to grow. Demand in the U.S. continues to grow. In much of the conversions that we've seen, KeelClip and other solutions, CUK has had a long history of very strong demand and appropriate supply, and that has really continued. SBS has been one that, though, to your point, has been more favorable. We're real pleased with some of the optimization that we've been able to do across our 3 substrates, moving some CUK demand into SBS; watching the foodservice business recover, which continues to recover nicely coming out of the COVID declines that we saw. And so whether you're on the folding carton side of SBS or the cup side, the demand profile is strong and is up on a year-over-year basis for us. And obviously, the foodservice business, recovering nicely. And so a little bit to the plus and minus that I know we talk about relative to food, beverage and consumer versus the foodservice side. But there, too, in SBS, it's important. I mean, inventory levels are down for ourselves and for the industry. As such, backlogs and operating rates are up. And so that similar $250 a ton move up across SBS, and we have another $50 that we're executing on currently, I think speaks to the overall supply-demand environment for SBS.

Steve, you mentioned a few things there maybe we can follow up on. The investments that you've made to increase your flexibility, can you talk a little bit about the Texarkana project and how that really allows you to sort of swing between CUK and SBS? And has the return profile of that project changed, given SBS seems like it's a bit stronger? I'm just kind of curious if you can elaborate on Texarkana.

Yes. I appreciate you raising that. I mean we're still very positive on the returns in the investment, but we've held off on making it a little bit that we kind of got that out into next year, even mid- to late next year mostly because of the demand profile for SBS. And so we're running very flat out across our SBS platform. There's some not insignificant downtime required to make the investment, and overall, the demand profile for SBS is quite good. And so we love the optionality of having it available to us, but we're being a bit patient on actually making the investment just because of what you said, the demand profile being -- we're ready to go. We've acquired the necessary assets. We just haven't pulled the trigger on the actual investment because of the demand profile that we're seeing positively for SBS.

And then another thing you touched upon, the kind of retail versus foodservice. I think you talked about it as sort of a teeter-totter. Can you talk a little bit more about sort of current demand trends there in retail and foodservice end markets and how investors should think about sort of net impact to volumes and mix as that maybe rebalances?

Yes. I think at the total company level, our confidence in the 100 to 200 basis points for organic sales growth remains very high. And so we expect to be in that a 200 basis point level this year. Confidence into '22 and beyond, that we can consistently be at that 100 to 200 basis points, remains firm because of the innovation pipeline that we have. We are seeing exactly what you said. We're seeing some recovery in foodservice. We saw it in Q3. We're going to see it again in Q4. And some of it is, some return to some of the mobility that you're talking about, obviously, more folks on airplanes, more folks getting out and about and the recovery. Our cup business is running very full. We talked that in Q3, we actually had a little bit of some challenge meeting that demand as we were upscaling the organization from a people perspective. The team is doing a great job of onboarding the talent necessary to meet the demand for -- the redemand, the resurgence back to demand levels that are positive year-over-year on the cup business as an example. So I think you'll continue to see that teether-tother play out as we have, and the net of it, we expect, will be that 100 to 200 basis points of organic sales growth.

Great. Great. And while we're still kind of on the supply/demand dynamics for the 3 grades, I mean in the past, the market has been impacted by imports or just maybe generally, supply/demand conditions in Europe and China with some of the boards that they're producing. How is this year different? Obviously, ocean freight rates are in a totally different place, energy costs in other regions, like how would you describe sort of North America's place in kind of the global boxboard market this year and maybe into '22 versus previous years?

Yes. Well, you touched on it. I think, obviously, we've all seen the realities of the cost to move ocean freight and the impact that, that's had both on supply chain as well as the cost. And as such, local capabilities, I think, have prevailed, in many ways positively. It doesn't mean that we're not -- that there aren't competitive alternatives from an import perspective. And generally, in CRB, there are none in CUK. They're extremely modest, mostly in SBS, mostly in the FBB category. There continues to be imports on the FBB front that have been more stable, modestly growing, probably consistent with the past. But in terms of new entrants or new participants, certainly, China, very modest. In fact, a step back in Asian imports into the U.S. So I think broadly, the realities of the supply chain environment have made more local production and closer to home production modestly advantaged when it comes to -- when you kind of stand back and look at how we're servicing ourselves. Now we do service ourselves elsewhere, so we're an exporter. So we've been working hard to make sure we can move product from our paperboards, the U.K., into places like Europe and Japan and Australia and elsewhere. And that's -- there's some cost implications associated with that, but we've been able to work that into our pricing, obviously, as we're looking at the value we're creating elsewhere for CUK as an exported item.

Got it. Got it. And while we're sort of on the topic of exports, can you talk about your European business and then the AR Packaging acquisition, which you closed relatively recently. What does that provide for Graphic Packaging?

Yes. I'll tell you, we're very excited about it. We closed November 1, so we're thrilled to have the entire AR Packaging team now part of the Graphic Packaging team. And so we're thrilled that it came together, and so we're very pleased. And overall, it's a lot of what we talked about. The business is such an excellent fit with what we're doing from an innovation perspective, from where we're focused around sustainability in terms of fiber-based solutions primarily and the innovation engine there based upon early observations and what we knew on the way in. We're very pleased with, overall, the footprint really expands our participation in what is a growing sustainability-led fiber-based environment throughout Europe and elsewhere. And so overall, we couldn't be more pleased that the acquisition came together and the team is now with us. We're also pleased with how the business is and has been performing. We now have the business in-house. The financial expectations are meeting the expectations that they established for 2021, and as such gives us confidence as we look out into 2022 in the acquired EBITDA and the expectations we have around synergies. So overall, a very good start. Our teams are working exceptionally well together now that they can spend time together, and we have a full integration team in place operating, every couple of week check-ins with our leadership here on how we're doing integrating the business in. So off to a very good start, and thank you for asking.

Can you talk a little bit about what AR is producing that's maybe differentiated versus your kind of legacy European footprint or just the broader GPK footprint in the U.S.? And I think most of the synergies are maybe more cost driven. Do you think about possible revenue synergies or cross-selling in the future?

We do, because the customer overlap between us was actually quite modest. And so some of the market participation strategies, very specifically around the pharma markets, health care markets, beauty markets. They also have a machinery business similar to our beverage packaging machinery business focused in on categories like baby food markets. So different categories within the food markets. And so those are some examples of markets that we actually, to your very good question, yes, there's the cost synergies that we have confidence in, but we're really looking forward to the potential revenue acceleration opportunities as we learn from each other. And some of that is footprint oriented as well. This is now a footprint that is much more Eastern European in its orientation. It opens windows for us even in our core traditional food, beverage, consumer markets where we didn't have manufacturing infrastructure that we can now leverage. And so we're -- I do believe, we believe now that we're together that there is real potential for good strong revenue synergies, leveraging. And a good example, we've really have had no presence in health care, beauty care markets and now we do, with a good strong footprint in Europe. That opens up optionality for us more broadly, even in places like in North America.

Got it. Got it. And just while we're on the topic of M&A, I mean, another recent acquisition was Americraft. Not as large as AR Packaging, but can you talk a little bit about that and maybe how it compares with some of your recent acquisitions in North America?

Yes, it's performing exceptionally well. Seven facilities here in the U.S., again, very limited customer overlap, more regional customers and the integration has gone exceptionally well. We've integrated the paperboard into the facilities teams, integrated into the company very nicely. They're doing a great job of obviously managing through the pricing environment as well, given some of the inflation. So very pleased with how the business is executing. It's meeting all of our expectations here in 2021. And as such, again, good strong confidence that the $30 million plus synergies for 2022 is there for us. Our plans are coming together nicely for that business as we look out into 2022. So when you add them both together, our confidence in the incremental EBITDA and top line from both of those acquisitions heading into 2022 is quite solid, both on the acquired EBITDA and on the synergy capture.

And I think the bolt-on acquisitions for you have helped to boost the integration rate over time. Can you talk about your current integration rate, where you have line of sight to that going? And then can you discuss why higher integration rate is sort of a part of the longer-term strategy and how much maybe upside you have by just kind of integrating some of these recently announced acquisitions.

Yes. No, thank you for that. If you kind of stand back where we are today, we're about 73% integrated. So it's moved up pretty significantly since we kind of go back to the beginnings of when SBS and the cup business became part of the portfolio. And so we've been moving up nicely. And with things that we have completed, in other words, with the acquisitions that we've completed, with the organic growth that we have line of sight to probably over the next 24 months, we should be getting to the low end of our Vision 2025 range of 80% to 90%. So we've kind of got a line of sight towards 80%, which is great, because we can see that in the context of the next couple of years. And that's based on known investments that we've completed and innovation that we expect successfully execute on. The value creation for us has really come in terms of margins and cash flow. I think we've been able to show that, overall, the margin profile that we can generate by having line of sight to our customers and line of sight to the ability to invest back behind the business is margin enhancing for us. We're able to optimize the footprint more broadly. And a great example of that is it's awfully tough to make a decision like Kalamazoo, a CRB major investment, if you don't have line of sight to your customers. And it's a great example of that will be a highly integrated facility, vast majority of the paperboard, the recycled paperboard, that will come out of there will go to our converting facilities and end up at our customers on an integrated basis. And that ability to have line of sight all the way through the integrated platform really creates the confidence that we can generate the returns when we put capital to work.

Got it. Got it. And we have a question here just on '22 guidance. I think EBITDA of $1.4 billion plus. When you think about maybe potentially the biggest risks to reaching that target, whether it's demand, pricing, commodity costs, labor costs, M&A integration, what do you identify as maybe the biggest swing factors for guidance next year? And then generally, are you expecting commodity cost inflation to worsen in '22 or ease or basically stay where it was at the end of 3Q?

Yes. Well, some of it -- first, our confidence in the $1.4 billion plus is very high. And we brought it out pretty early in the process. Obviously, given the importance of what we are executing on, on pricing and the AR acquisition, Americraft, the Kalamazoo investment. If you look at the components, broadly, our confidence in the components is high. And so what we just talked about, AR and Americraft, high; price execution, high. Obviously, we're confident that Kalamazoo is going to start producing paper here in Q4 and that we'll get the first $50 million of EBITDA value created in 2022. So our confidence there is high. We're obviously executing on that as we speak. And so the variables, they tend to be what you were just talking about. I mean, it would take some pretty substantial dislocation, I think, to disrupt the $1.4 billion. I think our confidence in the pre, the plus is very high, and so I think downside risk is pretty modest. What we're certainly focused on is extracting the maximum value from those investments that we are making and the things that we can control. If we see dislocation like a continued acceleration of inflation, we'll take more pricing because we will know that we'll need to. But we've done a nice job of getting out ahead of the pricing such that the value that will be coming in the pricing front pretty effectively in early 2022 is quite high. So broadly speaking, obviously, demand is always something you keep your eyes on. But as we pull our plans together for '22, our line of sight into the innovation and the organic sales growth, that 100 to 200 basis points, remains high as well. So obviously, the global economy will matter, so we'll always be attentive to what's happening relative to overall, whether it's inflation, whether it's recessionary or growth type environments. But as you know and you know this business well, we tend to weather through those defensive or offsets of environments pretty well.

And one headwind that you saw in 3Q was around, I think, labor availability in foodservice as production kind of ramps up after the pandemic. Can you talk about the time line for those issues resolving? And just generally how you see labor playing out into '22? Is that getting better or worse? How does it impact GPK kind of within the 4 walls and then your customer set?

Yes. No, great question. And Q3 was pretty specific. A couple of things we had, obviously, we were ramping back up in our foodservice business. A couple of hundred people that we had taken out of the business as part of COVID, we were putting them back in. And it took us some time to do it, but it's going well. Teams have done a nice job. We're ramping back up here in Q4, running quite full. So I don't think -- you won't see a repeat of that conversation in Q4. And overall, some of the earlier supply chain issues, some of the weather-related challenges in the Northeast, one of our facilities, in the Northeast being taken out, we obviously have redistributed that business around and are bringing that facility back to life. So I think overall, the organic growth side should be supportive of what we've been talking about. That being said, you're on to and I'm sure you hear quite a bit, I mean the labor environment is a challenge. And as such, we are seeing some inflation at the -- more at the entry level and then some of that rolls through. We've got great contractual relationships with our unions as well as obviously with our nonunion teams. I would expect we'll see a little bit at the high end of our historic range on labor inflation. We'll take that into consideration when we're moving the business forward. But our ability to attract and retain employees, obviously, is a critical factor for us, certainly diverse and highly inclusive organization broadly. And so I feel real good about the progress we're making. But it's a tough environment in that. So we have -- we've got to stay very attentive to it.

And 1 project you did mention, but maybe I just wanted to circle back on Kalamazoo. Can you just give us sort of an update on the time line for sort of paperboard production there? And the kind of expected EBITDA contribution return for the project, any update?

Yes. As I mentioned earlier, I think what's great is we're more excited about the investment today than we were even when we took the decision, which is nice to be able to say a couple of years later after when we took the call. And so we're looking forward, we're going to start to make -- producing paper here in Q4, and so we'll be up and running. The benefits themselves probably that first $50 million, pretty modest in Q1 just because we're going to be dialing in the machine and the capabilities, and the team will be doing a great job of bringing it to life. Most of the economic benefit probably starts to emerge Qs 2, 3 and 4, but by the time we exit out of the year, we need to be and will be on a run rate. I know that's where we need to be because we've got to get the next $50 million in 2023. So I think Q1 will be a modest ramp just because we'll be dialing in and working out what is -- we intend to be a pretty vertical start-up, but there'll be a little bit of that happening in Q1 and then the benefits should start to come in Q2 and beyond.

Got it. Got it. And maybe I've saved the best question for last, but can you talk a little bit about sustainability and really specifically plastic substitution in terms of the potential sales impact, the long-term opportunity, when you started to really see an acceleration there and sort of where we are in that journey?

Yes. If you kind of stand back, we've talked about a $7.5 billion addressable market for our organic sales platform, and $6 billion of that is plastic substitution, and I'll put foam into that category as well, so plastic and film substitution. And so really, the majority of our organic sales growth this year will be in plastic substitution, whether that's beverage packaging with wraps and KeelClip and the like, or it's PaperSeal moving away from plastic or foam or resin-based trays, whether it's cup conversions into fiber-based cups away from either foam or plastic cups. So really, at the core, it's the majority of the organic sales trajectory. One of the things we're looking forward to talking about probably in February when we next -- or having our Investor Day is the size of that $7.5 billion addressable market. This is, in fact, bigger now with AR Packaging. So we're doing that work right now on does that open up the aperture a bit even on what's possible relative to the organic growth potential of the company? So yes, elastic replacement or other resin-based or foam-based replacements are really the majority of what we've seen in terms of that we'll call it, 200 basis points this year, really, the vast majority of it falls into that category.

And did the pandemic -- how does it impact sustainability initiatives for your customers? Did it kind of put things on pause or did it maybe accelerate initiatives? Are you kind of like working through maybe a bit of a backlog? How did the pandemic impact sustainability, do you think?

I think without a doubt, just as many, many businesses, including ours, had to adjust to the realities of COVID, I think there were some instances, particularly early on, where we saw some mostly delays, not eliminations, but some delays, KeelClip installations and the like. As businesses have settled back in, our customers have settled back in, we like the momentum. Projects are in motion. Investments are being made. And so overall, to your point, and it's one of the reasons our confidence in the 100 to 200 basis points is high looking out into '22 and '23, is that we can see the projects. Because these things do take some time. They are conversions. They actually require investment on behalf of our customers as well. And we can point to those pretty well as we kind of look out into certainly line of sight to very specific projects in '22. So the backlog to your question is a good one because the actual number of projects in that tend to be singles and doubles as we've talked is actually quite good.

And some of the products that have really driven this, I mean, whether it's KeelClip or PaperSeal, is -- of the 3 grades you produce, is CUK the biggest sort of winner or beneficiary of plastic substitution? Or is it sort of spread evenly between the 3? Or how should we think about the impact to the individual substrates?

Yes, it's -- thanks for that. It's nicely being spread. Obviously, CUK for -- is clearly there when it comes to CUK. But PaperSeal, for example, is more SBS-oriented in terms of the substrate. It tends to be more of a white on both sides type solution. We're seeing some solutions as well that, as I mentioned just broadly, the demand for CRB is stronger than it has been historically. So it's pretty nicely distributed. Obviously, as we talked earlier, we're kind of optimizing across the substrates. But I would say that the virgin grades, our CUK and SBS, are seeing a nice percentage of the growth, and then we're doing the optimization across the total platform.

Great. Great. Well, Steve, we're coming up on time. So I want to thank you for your time and really sharing the progress that you've made this year and the outlook for '22. So with that, thank you.

Absolutely. Thank you. Thanks, everybody, for joining in. Have a good holiday as it approach. Anthony, good talk to you. Take care.

Thank you.

Bye-bye.