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

All right. Well, good morning, everyone. Thank you for joining us in today's presentation. My name is Josh Wilson. I cover packaging materials for Raymond James. And joining me today from Graphic Packaging is Steve Scherger, unless I get it wrong.

That's right.

There we go. He's Chief Financial Officer. And Melanie Skijus, Investor Relations here in the front. For those of you who may be new to the story, Graphic Packaging is a vertically integrated manufacturer of paper-based packaging. Their primary end markets include food, consumer and beverage. Today's presentation will be a fireside chat. I'll start with some of my prepared questions. But if you have a question along the way, we'd like to keep it interactive, so feel free to raise your hand as we go. And with that, thank you, Steve and Melanie again for joining us.

Yes. Thanks, Josh, for having us.

Just some introductory questions, maybe for those who are new. Graphic is the largest manufacturer of fiber-based consumer packaging in both the U.S. and Europe, somewhere around $9 billion in sales in your guidance this year. In what way is this scale an important advantage in your industry?

Yes. Thanks for that, Josh. I think I kind of stand back and think about scale, I tend to think about it in a couple of different ways. One is having scale allows us to work with the world's small, medium and largest CPGs. As you mentioned, we're almost entirely a consumer packaging company, view ourselves as a packaging company, the vast majority of the products we make or the products that we, as consumers, take off the shelf. So think about your 6-pack or 12 pack of beer or your Starbucks cup or other packaging products, as you were mentioning. And that scale gives us the opportunity to really be able to very effectively at very low cost and high quality service those customers, wherever they may be. And we're primarily a North America and European based business, more mature markets in our orientation. But as such, we can work with some of the largest CPGs in the world to provide them with extreme consistency globally to protect their brands and to produce products that work for us as consumers. The scale also gives us the opportunity because we drive a very integrated model, meaning we produce the paperboard, that is the primary raw material and then converted into that end product. The scale that we have really allows us to optimize those assets. And by driving a very integrated approach, we can optimize within that when it comes to optimizing production at our big, large paperboard mills and leveraging a very large 100 operation network of converting facilities that are located proximate to our customers' locations. So scale also gives us the opportunity to be where they are. Because as we all know, certainly in the environment we're in, you want to move things around as little as you can relative to how we are effective. So I think of scale both at our customer level and then within our physical operations.

Excellent. You also operate paper mills, as I mentioned, there's some vertical integration here in North America. They currently supply over 70% of your conversion plant needs. What investments will you need to make to reach your 2025 goal of over 90%?

Yes. You're talking about integration rates. And so we produce about 4 million tons of paperboard today, and about 72% of that we turn into the end products. Our goals that we have articulated in Vision 2025 is for that 72% to drive up towards 90%. There's really 3 things that give us confidence on that trajectory. One is that we'll continue to grow organically. So we're growing organically as more fiber-based solutions are preferred by consumers and our CPGs are making investments in fiber-based solutions, replacing other alternatives. That will drive 3% to 6% of that growth, [ 300 to ] 600 basis points from the 72% up towards the 90%. We also purchase almost 1 million tons of paperboard from other producers of paperboard, and that presents a very significant opportunity to internalize that paperboard. And so to make it ourselves, sell it to ourselves, turn it into the end product. We've got a lot of optionality over the next several years to drive integration rates up through internalization of paperboard that we acquire today or purchase. And then we also have historically driven integration through our M&A through buying businesses, converters who may be buying paperboard from a variety of sources today and then internalizing that. So we really like the trajectory of low 70s when we actually go back a few years when we brought in the SPS platform with international papers businesses, it got into the cup business, we were integrated into the kind of mid-60s this year. In 2022, that 72% will probably drive up towards 75% in 2022. And then the 3 things I just mentioned really give us line of sight to 90%.

Excellent. And do you think you'll be investing in paper mills in Europe? And why or why not?

Yes. It's not at all required for us. When we laid out Vision 2025 kind of the path I was just referencing, it's not a requirement for us because we service our European needs today very well by and we export CUK, 1 of the 3 paperboard substrates. We export to ourselves in Europe and around the world to drive the integration that we were just talking about. We're then a net buyer of paperboard in Europe. So it's not required for us. We've always had it as kind of optionality, but when we look at the supply/demand dynamic, one thing that's true about Europe is demand for paperboard right now is very high. But you've seen some capacity addition announcements here recently. [indiscernible] recently announced a conversion that may drive some needed paperboard production. So we'll monitor that. We'll be a good buyer of paperboard, very effective one, where we need to. We'll drive integration rates by exporting to ourselves. So it's not really a requirement for us to execute on Vision 2025.

Got it. And then you mentioned the growth driver from customers switching away from plastic packaging. Obviously, that's very interesting to investors. Your stated goal for annual organic sales growth is 1% to 2% over the long term. Support that goal and maybe talk about why the transition to plastic won't happen faster?

Yes, good question. What we've seen over the last few years is, obviously, we aspire for it to be faster. We put goals out at 100 to 200 basis points of organic sales growth through really a portfolio of innovation efforts that we have. We've identified about a $9 billion addressable market for conversions into fiber-based solutions. About $7.5 billion of that is plastic replacement, so it is the majority of it. And what we really like about it, and we've seen it over the last 2 and 3 years where we've grown organically 3% and 2%, that it's a portfolio of solutions that allow us to drive that organic growth. And what I mean by that is, it's a lot of -- in baseball terms, a lot of singles and doubles. We're winning in beverage packaging with solutions like KeelClip that replace plastic rings and other resin-based wraps. We're winning in paper cups out of foam and plastic conversions as decisions are made to move towards the fiber-based solutions. We're winning with a product called PaperSeal, which is, think of it as meats and cheeses and the like that are used to be in foam or plastic solutions that are moving to fiber based. So it's a portfolio of solutions. A lot of them are plastic replacement very specifically. Some of it, obviously, the consumer has a desire for the product to be in a recyclable renewable. And thankfully, paper solutions are the most recyclable in terms of the actual reclamation rates being very high compared to other alternatives. So that's what gives us the kind of line of sight. The last 3 years have been important because we've been able to show that the portfolio of innovation efforts driving 2% to 3% growth gives us confidence in the 100 to 200 basis points. Obviously, if we can aspire towards the high end of that or beyond that, that's certainly what we're working on day and night, but we can see 100 to 200 basis points for the next several years.

Got it. Occasionally, you hear a story of someone switching back to plastic packaging. Why might this happen and doing the new products you're developing address those opportunities?

Yes. And we've talked a lot. We don't win every competitive environment, every jump ball. There's always good decisions for the right reasons that companies make to invest behind all of their solutions, whatever they may be, and there's a time and a place for all of them. I think what we've seen is in a couple of instances where a customer elects to either increase in investment in plastic or retain one, a lot of that oftentimes is around SKU rationalization. So they're taking a series of products, and particularly maybe the example you're referring kind of a food service application where you're taking and reducing the number of SKUs and driving -- hopefully driving efficiencies within the facility. And so that would be an example where cost and SKU rationalization would win over other decisions that might be made.

Makes sense. Let's transition to pricing dynamics. Pricing has been a substantial driver of margin expansion in your 2022 guidance, but you didn't even include the most recent price increase in that guidance. So can you walk us through, just for those who are new the mechanics, how your price increases work and when the latest one will start impacting your profit and loss?

Yes, just a little bit. Obviously, we're all navigating through a very unprecedented inflationary environment across our company last year. We purchased -- procured about $2.5 billion of commodities. So think wood, OCC, logistics, chemicals, freight and the like, other resin-based products to support the products that we make. We saw $330 million of inflation across that basket of spend last year, and we're estimating we'll see another $300 million to $500 million this year. As such, we've been taking numerous price actions. Pricing for us tends to come in the form of about a 6-month lag from when we execute on it with our contractual customers to when they receive that price increase. So we do operate a bit of a lag last year with numerous price increase announcements. We had about $150 million of pricing. Think of that in the context of the 2 inflation buckets that I just referenced. We've got line of sight to $700 million of pricing this year. That's contractual. It's being executed on. It's all started to a nurse significant benefit here literally in January, and we'll have line of sight to the first $200 million of that here in Q1. And in addition to that, what was not in the guide is we had some additional price increase announcements that were partially recognized here a couple of weeks ago that will endure some positive benefit here in 2022, probably in the $40-plus million range for this year. And then, obviously, the rest of that will endure benefit into 2023. We just continue to operate in a very positive supply-demand environment so that obviously, supply/demand is what rules the day when it comes to pricing and because it's been required, obviously, given the inflationary environment.

And you mentioned contractual relationships, how long your contracts with customers last? How sticky are those relationships?

Yes. We're very fortunate. The vast majority of our customer relationships are very long lasting. Obviously, we have new customers that come our way with some of the conversions that we were talking about earlier. But the vast majority of our relationships are very contractual with our customers. They'll be as short as 1 year. We've seen that a little more in places like Europe for as long as 5 [ years ]. And so on balance, 2 to 3 years is kind of in the norm for our contractual relationships. So we're always renewing and earning the right to retain our relationships with our customers. But retention rates across our band of customers is very high because we're investing with them and behind them. When they're doing business with us, they tend to have a large percentage of their packaging needs, their fiber-based needs that we're doing on their behalf. And as such, they know that we're investing behind them in terms of lowest cost and the highest quality capabilities and the innovation engine. And because we oftentimes find ourselves partnering with them to drive their innovation agenda, their ESG initiatives, their sustainability initiatives, we're an active part of that with them.

Excellent. Just to check with the audience to see if anyone has any questions so far. If not, I'll keep going. Okay. So your stock was pressured late last year when a competitor announced plans to introduce new mill capacity in 2025. How should investors think about the risk of excess capacity additions in the industry over the medium term, both in that specific case and more generally to?

Yes. I'll talk about that specific case. I think one thing that we do believe relative to someone making an investment in the industry over the next several years, potentially, and I'll talk about it specifically, is that demand is increasing. Here in North America, demand for paper-based, fiber-based solutions, the kind of packaging we do, CRB, CUK, SBS, the virgin and recycled substrates, demand has increased, and we see that. We've seen it in our results. And so on the one hand, we absolutely believe that the demand profile for what we do will continue to grow. That specific investment being made by BillerudKorsnäs is one that we talked about at our Investor Day. I think it's conversion of a mill in the Upper Peninsula of Michigan. And I think 1 of the things we're focused on is, well, what's that investment likely to look like? It's probably a 2025 or 2026 investment in terms of the realization of it, probably at the earliest. And it's more likely to be focused on what is called FBB, which is -- what is the European equivalent of SBS, weighed on both sides, tends to work in food service applications and other health, beauty type applications to end. We can see that, that investment could be in FBB, one that could be brought to life here over the next several years. We don't necessarily see it competing with CUK, which is our -- the primary brand for beverage packaging and the like, the trees in the Upper Peninsula don't necessarily nerve the sign of strength benefits that we have in the Southern United States. So that's something that we were mindful of as we were trying to look at where the competitive dynamic would be. And as you were talking rightly earlier in 2020, we'll be a 90-plus percent integrated business with very long and robust relationships with our customers, and we're certainly going to continue to build the company -- the packaging company that we are over the next several years. So we never avoid the realities of a competitive world that we operate and live in. But that's 1 that we think we we'll definitely continue to monitor actively, and we kind of know what that competitive landscape is likely to look like.

Got it. Okay. Another topical question, obviously, the conflict in Ukraine is very tragic and top of mind for everyone. Can you quantify your exposure to Russia in terms of sales and production?

Yes, I'd be glad to. And obviously, our hearts and thoughts are with the people of Ukraine and all that they're enduring here, first and foremost. We do not have operating assets in Ukraine specifically. With our AR Packaging acquisition, we do have 2 small facilities in Russia. It's about $100 million of top line, so really 1% of the company. It's less than 1% of the company from an EBITDA perspective. So overall, it's not a material component of who we are. We're hearing completely to all and everything that's associated with sanctions and how that business is operating on a limited basis today. We've got good contingency plans in place for where we're producing in the region to support our customers' needs. Obviously, long term, we'll certainly assess the footprint.

Makes sense. And do you have any significant customer exposure there beyond your own facilities?

Our customer exposure are mostly with CPGs, the folks that we sell to today that the business in Russia sells to specifically has been more in the food service markets and the tobacco markets.

Okay. And then what impacted spike in European natural gas prices have on your business in '21 for a review? And then also what might the impact be in '22 at current levels?

Yes. For our business because we're in Europe, we're a converting business. So numerous converting facilities, so doing the printing cutting, gluing of paperboard for the applications we've been talking about here. We saw some inflation, obviously, nat gas and other materials, that's factored into our pricing and our inflation assumptions for 2022 specifically. I think what will be more interesting, we're not a producer of paperboard in Europe, as we talked earlier. Nat gas tends to have more of an implication on the cost structure for making the paperboard. And as you're seeing energy costs go up and the like, in Europe, generally, the price of paperboard tends to move more annually in terms of the negotiations. I think this could be a unique environment where costs could move up more materially. We've certainly conveyed to our customers that if that happens, we'll have to move our pricing up commensurate with that. So it's a little more of a dynamic environment than we've probably seen in the past, but one that we are confident that we'll manage through in terms of moving that pricing through where it's needed to do. Obviously, these are pretty unique times relative to the inflationary impact on the European economy.

Makes sense. There's anyone else in the audience? Okay. So what gives you confidence in your long-term guidance of $50 million to $70 million in annual net performance improvement within your EBITDA outlook?

Yes, it's an important question. And just for those maybe not as close to it, every year, we consistently try to drive $50 million to $70 million of just core productivity in the company. It's -- some of it's capital supported. Some of it is just the day-to-day making the business better. And our confidence is high because we've got on a long track record of having done that over the last decade. And we have very steady and consistent 3- to 5-year capital spending plans where we're consistently pointing at what are the projects that are in our core CapEx that can consistently drive that $50 million to $70 million. And our line of sight to that is high. Our -- the list of projects, if you will, actually gets bigger, not smaller, as we grow as a company. And that's projects like curtain coaters in paperboard facilities that take TiO2 out of the production process or automation investments that reduce the need for low-skilled labor. Obviously, we want high skilled and high capable labor throughout our organization and our teams. But there are certain roles that where we can drive automation and encourage our colleagues to be moving into higher capable, higher skilled roles over time. So those are kind of the investments. We've got good line of sight to them. We know what they are and we're a bit [indiscernible] making sure that the returns from those investments come our way.

Excellent. And Cash flow is also one that gets a lot of investor attention, and you recently increased your long-term CapEx expectations from 5% sales to 5% to 7%. Why was that an appropriate move for CapEx?

Yes. As we looked at our capital allocation priorities and the update division 2025 that we provided here a few weeks ago, what we -- a couple of things that we accelerated and actually advanced forward in that vision. And one was an EBITDA target margin in 2025 of 20%. It was a range of 18% to 20%. And we targeted towards 20%, we think we see line of sight to that. And part of that will be the potential for capital to be more up in the 6% to 7% of sales with returns on those investments that give us confidence that we can head towards that 20% EBITDA margin. So it's related to the return profile of the company, obviously, for us, generating returns above the cost of capital are critical. We've been on that march now for several years, and that's part of the balanced approach to capital allocation that we're so committed to.

Excellent. Can you give some color maybe on what return requirements you set on growth CapEx?

Yes. It obviously depends a little bit on the size of the investment. It will range all the way from a truly unique investment like Kalamazoo, which is a $600 million investment where you're out into the 10% to 12% range to smaller CapEx, [ $10 million to ] $50 million to $100 million, that tends to be 15% to 20% because it's higher return, shorter, quicker in its orientation. So we really look at it across the lens of both the end returns on that capital, the payback time lines for it. And for us, it really just comes down to can we see it, and we tend to invest in our best assets. Just philosophically, we tend to put money behind. And with those assets that have the strongest returns to make them better. We have found that, that's actually where we get the right kind of returns on the capital as opposed to kind of making lower return businesses or assets incrementally better. They don't ever tend to actually leap over the bar of cost of capital type returns.

Got it. Okay. We're down to about 5 minutes. If anyone has -- okay. We'll start over here.

[indiscernible] [ $9 billion ] [indiscernible] think about the strategy [indiscernible]

Yes. No, thank you for that. And the question was around our $9 billion addressable market. We actually increased that to $9 billion here a couple of weeks ago back in September of 2019, it was $5 billion. And with all that we've been pursuing, both via acquisition and just the addressable market continuing to grow, it's now $9 billion. $7.5 billion of that is plastic substitution. So the majority of it is substitutions like we were talking about earlier, plastic substitutions in beverage packaging, food packaging, food service packaging, consumer packaging a lot of the characteristics of the innovation engine that we talked about earlier. There's a strength packaging component in there as well, where we're replacing what would have traditionally been a corrugated box with a fiber-based solution like CUK or heavy caliper CRB. Think of that as if you're in a club store and you're walking a large club store aisle and you're looking at a 24-pack of a product or a large box of a product that you're going to take home, a lot of those used to be in a corrugated box, and we'll tend to move them into our virgin or recycled paperboard solutions. We also have a pretty large addressable market for our microwave, our cooking solutions business. We've got great technology for having microwave foods be cooked very evenly. It's a high -- actually high-technology product. And frozen food consumption is actually up and has been a growing market here, particularly over the last few years just relative to the convenience of it. So when we look across, it's a portfolio of the $9 billion, plastic substitution makes up the majority of it. And I think to your good question around, I think what we are finding is that fiber-based solutions that have excellent appeal relative to the brand itself function well with us as consumers and then are recyclable and do move back into the waste stream really for us, speaks to the circularity of what we do. I think one of the things about Graphic Packaging in the business we are, we'll take a product, we'll make it the first time from virgin paperboard with renewable forests that are extremely well managed, and then we'll make that product 5 to 7x, again, as a recycled product. And that circularity is very powerful relative to the realities of collection and recycling efforts, which we continue to be supportive of improvements in recycling. You see a lot of major metropolitans in the U.S., for example, being more receptive to taking paper-based products that maybe they didn't take in the past because we can recycle them like that cup that's sitting there on the table. And so those are really, I think, at the core kind of why the fiber-based advantages and the consumer has tended to have spoken around just a bias or a preference towards those types of solutions, knowing that they operate in a way that's much more circular.

I think we have another one over there. Yes. Go ahead.

Yes. Can you talk a little bit about your capital structure and [indiscernible] your market buyback, your cost of leverage [indiscernible] think that your desire to [indiscernible]. So how do you think of [ that plan? ]

Yes. Thanks for that question. And we do think about our allocation of capital, very much what you were just describing. It's what are the options for putting capital to work back in the business that have returns that are at or above cost of capital consistent with our aspirations. Let's make sure the balance sheet is in a very good spot. We've actually said that our leverage target 2.5 to 3x is a place where we've operated very successfully. It's 1 notch below investment grade. Long, long term. Investment grade is in the realm of possibility. It's just not the highest priority for us right now because we are a bit uniquely levered in the mid-4s on a pro forma basis. So 2022 and 2023, we've been very clear that delevered -- taking the leverage profile down towards this year, 3 to 3.5x. 2023, back down into our targeted range. So in the next 24 months, we've got a very clear line of sight to getting leverage back down into that kind of range. We've been opportunistic in the past around share repurchases where we fundamentally believe that the value of the corporation is well beyond where it was being valued. And if you went back over the last 3, 4 years, we actually bought back 20% of the company at rate dollar -- kind of in the $12, $13 a share range, which was a good use of capital at that time based upon our confidence in the forwards. We have a modest dividend today, probably not a priority to increase it in the short term. It's a modest use of cash flow today, $100 million or so. Over time, we'll probably address that. But I'd say if you kind of stare at it, we're always looking across the totality of that in addition to M&A and how we put capital to work. We've been very acquisitive in the past. So it's really the entire portfolio of decisions and at any point in time, we place priority and emphasis on those things that we think are going to narrow the most value to the -- to our stakeholders. But thank you for asking that.

Other questions? Okay. Well, I think we'll leave it there for now, and we'll do more questions in the breakout, that's going to be in Cordova 1.

All right. Thank you all very much.