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

Great to see everybody in the room. Good to see Steve Scherger here.

Thank you, George.

Well, now you're here, let's have a fireside. What do you say, Steve?

I think that's a great idea.

Yes. Just [indiscernible] prompt.

Highlight of the day, for sure.

We'll take it. As you know, Steve is Executive Vice President and Chief Financial Officer of Graphic Packaging Holding Company that we hold in high regard. From October 1 of 2014 through December of 2014, Steve was Senior Vice President of Finance for the company. Has a long career, both at Graphic as well as within the industry. A font of knowledge and -- no pressure, Steve.

Yes. I appreciate the...

We're looking forward to your comments today. Coming out of earnings season, there's a lot of discussion about price cost, the outlook for '23. I remember some questions about capacity too. So we'll probably talk a little bit about that perhaps. But thanks for being here...

Yes. No, thanks for having me. Thanks for the folks that are joining here this afternoon. It's good to be here, and good venue.

And the plastic guys, we're all talking smack at the luncheon. So it's...

Do we need to go longer?

We'll get into it as we need. So I guess the first thing relative to your guidance, and it wasn't that long ago that you provided it, the $1.7 billion to $1.9 billion of EBITDA, the $2.50, $2.90 of earnings per share. Remind us what some of the biggest supports are and perhaps some of the headwinds are as you look at that. And again, it's early in the year, you forecast your forecast. What do you see as a potential upside or downside tensions there?

Yes. No, thanks for that and obviously, coming out of a very good 2022, we were very pleased to pull forward guidance for 2023 kind of the components of which you touched on, heading towards a $10 billion top line, the $1.7 billion to $1.9 billion EBITDA, midpoint of $1.8 billion, that's up $200 million year-over-year, which is consistent with the investments we've been making in the business, generating $600 million to $800 million of cash flow along with making a 3-year investment in a new CRB mill in Waco, Texas, which I'm sure we'll talk about. So the ability to do both in there is fantastic. And as we also mentioned in the guide, taking leverage down towards the 2.5x range coming out of 3.2x at the end of 2022, which was in the 4s when we acquired AR Packaging at the end of 2021, so debt reduction being a very high priority for us. And then EPS $2.50 to $2.90, again, a significant step-up from $2.33 I think it was in 2022. Key components are exactly what we've been executing on, which is to continue to execute on pricing that is representative of the value of the products that we produce. And my reminder, we're a fiber-based consumer packaging company. We make the end products that you, as consumers, take home. Our customers are the Anheuser-Buschs and the Kellogg's. We make the end products that we, as consumers, utilize, the cups that we carry, the 6 packs, the 12 packs, et cetera. And so continuing to executing on the price initiatives necessary to offset the commodity input cost inflation environment that we've all been wrestling through. We've done that very successfully. We'll continue to do that in 2023. We've set a target out of continuing to grow organically 100 to 200 basis points. We now have 3 years of growing at 3% organically, driven by our innovation engines and a move towards fiber-based solutions preferred by the customers and our -- and we as consumers. And then our productivity initiatives. So Kalamazoo, our initial CRB investment, has gone extremely well. We got the first $47 million of value from that in 2022. We'll get the next $50 million plus in 2023. It's been a phenomenal investment for us and is operating at very high levels. So that combination of price, organic sales growth and earning on it and then productivity that more than offsets the realities of labor benefit, cost inflation is how we'll continue to improve margins this year and continue to do to execute at a level consistent with our Vision 2025 aspirations.

Would it be fair to say and recognizing it's only the first of March, and not trying to get you to say something that you don't want to say. But given where we are at the moment, would the tensions be maybe to the upper end of your range or the upper half of your guidance? Or is that, gee, George, that's even at this juncture, we don't?

Well, it's sort of...

A lot can happen with...

Of course. And a lot can move and we've seen incredible volatility on commodities and the like. But as we talked on the call, and it's worth repeating, we did put a pretty wide range out on inflation, appropriately so, given the environment that we've all been operating inside of. But currently, the kind of $100 million to $400 million of commodity input cost inflation assumption that we have is operating at the lower end. And so if there was a bias, it would be midpoint and up -- if there was a bias on today. That's not a statement of moving anything, obviously, George. But I think that's the natural bias as we're navigating through the realities of a lot of movement up and down on the commodity side.

Okay. So a number of people in this room right now, a number of people listening on the webcast. This is over in 23 minutes and 45 seconds. What do you want people to take away as the reason that they talk to their PM or they talk to their trader, we've got to buy more Graphic Packaging right now, or not? Obviously, I think you're probably biased there. What would it be?

Yes. I think if you stand back, there's a few things that who we are as a company, the business that we've been building, the business we continue to build. This is a packaging company. We're a fiber-based consumer packaging company. We're in all of your lives every day, and we're in it in kind of the nondiscretionary part of your spending. It's how we eat. It's how we drink. It's how we drive through the Starbucks or the Chick-fil-A. And that's the business that we are. And if you believe in the resiliency of the consumer and then how they spend their nondiscretionary dollars day in and day out. If you believe that there's just a natural bias -- not an always, but a natural bias at the consumer level for products that are modestly better for the planet, recyclable, renewable if you believe that fiber-based recapture rates at 60% to 80% is a good thing and allows us to make products the first time and then make them 7 to 8 times again. That's probably one of the unique circular economy companies that we are. And if you believe that we're good solid allocators of capital, then you should continue to invest in the company. And so I think it really comes down to our confidence in the consumer or a confidence in a -- reasonable confidence in a circular economy or confidence in our ability to allocate capital thoughtfully. I think you believe those things and you should be absolutely weighing in hard on us.

Thank you. Appreciate that, Steve. Any questions from the audience to start? Maybe a quick question here coming out of our luncheon discussion. I don't know if you had a chance to sit in on that?

I did not, by the way. So I apologize.

You have a busy day today. We were talking about fitness of purpose. And so not every package can serve every purpose. Even though fiber is recycled significantly more than other materials, it might not work in some applications. And that is a true statement. Where are you beginning to push further on the edge to make fiber fit for purpose in some applications that might not have been the domain of fiber-based, which could be pretty meaningful for you in the next few years?

Yes. No, in fact and by the way, I agree with the broad statement that everything does need to be appropriate fit for a purpose. And it's -- I think what we have found interesting is that when we brought Vision 2025 to life in September 2019, we worked hard on what's an identifiable addressable market for what -- where we can grow fiber-based solutions in our markets, food, beverage, food service, closer in consumer packaging type products. And the answer was $5 billion. And over the last 3 years, as we've refined where are the real tangible opportunities where we can win, that identifiable market now, addressable market for us is $12.5 billion, much larger. And it's because we see very real examples where fiber-based solutions can fit for purpose extremely well and broaden out our participation in categories. And what I mean by that is we're much more involved in the on-the-go consumption about the grocery store with bowls and trays that are now fiber-based as opposed to other alternatives. We've seen significant movement from foam cups into fiber-based cups. We're seeing much more activity perimeter of the shopping experience with fruits, vegetables, meat, cheeses. And so where we play is widening out very substantially. And it's also gone into some adjacent but new consumer categories. We're involved in packaging of batteries that we've never played in before. We're evolving with some of our fiber-based solutions to some can replacements and things like coffee and baby formula -- baby foods. And so as we look at what's possible, and again, to your point, don't win every jump ball, but the addressable market being much larger really has given us the confidence to say, "You know what, there is 100 to 200 basis points of organic sales growth over the mid- to long term that we can and should stay committed to, innovate behind, as well as really commit ourselves to earning on with the new products." And over the last 3 years, the 3% organic sales growth, 200 basis points of that are new-to-the-market products fitting exactly the categories we've talked about. And so it comes in pieces and parts at a time, but that's really what gives us the confidence that there is a net positive organic sales potential here for the business that we've been executing on and can continue to.

Don't spend a lot of time on this, Steve, but just a quickie. You -- part of your move towards -- not move, the impression you want us to have is you're a packaging company, not a paper forest company. You've moved off of the tons, data. I'm not phrasing it the right way, but wouldn't it be a good thing to also provide that along with the organic revenue? Or said differently, why not provide tons along with organic revenue?

Well, we made the move because we're really -- because we are -- our customers are the CPGs. We're really measuring ourselves like they do, which is are we making more products that are in the marketplace as measured by the volume of the end products that we sell? Keep in mind that of our $10 billion top line this year, 85% of it is going to be making that end product, making the actual box, the cup, the tray, the bowl. That's how we measure volume growth and mix enhancement. We actually break price out entirely separately, as you know, because we want to know that we're getting appropriate value for the products and offsetting inflation that's coming through the business or more than offsetting it. But I think it's the right metric. The reason also tons have kind of gone by the way side, it's a bit of a dated language for the business to be candid. We're not a paperboard producer. We actually produce paperboard. We produced 4.2 million tons. We buy 1 million tons. And so we're always optimizing the totality of the system, and I think oftentimes candidly, paperboard tonnage metrics really get lost in the interpretation because of downtime and weather-related incidents and you get an overreaction. So I think we've made a good pivot towards the organic sales growth metric that we put in place in 2019.

Thanks for the thoughts here, Steve. So we had -- you had a relatively weaker December. It was pretty consistent across most of the consumer packaging companies that we track. You saw a bit of a rebound in January. Again, not trying to put words in your mouth. Are you -- what should give us confidence that, that continues, if you can talk to that, and how it maps to your 100 to 200 basis points?

Yes, no good news, no change from what we talked about on the call. You said it well, December was a slow month for us, I think, broadly. I think everybody went home and took some inventory and working capital out of our respective cumulative industry at the customer level, and we snapped back nicely in January and our commitment sitting here with you to the 100 to 200 basis points for 2023 is quite sound.

Okay. And a question that we've gotten recently, and it's a tough one, answer where you feel you can and feel free to punt if you need to. Obviously, some of the other boxboard grids that really aren't as consumer-oriented as yours have started to weaken a bit. Should we view that as a precursor for potentially at least something you'll need to manage against across your grades or -- I'm not trying to get to make a forward-looking comment on pricing, which you can, but...

No. And I don't need to actually have any forward-facing commentary to kind of draw the distinctions because I think where you're going is -- all that we do is about the consumer and as I mentioned, kind of the nondiscretionary part of the consumer's life. So our demand profile is holding up extremely well as we just talked. And we expect that to continue to be the case. Over the next several years, there's very little capacity coming into the markets that we're participating in from a paperboard perspective, to your question a moment ago. So the supply-demand environment as such the pricing environment has upheld itself very consistent with what you've seen to date. That distinguished itself a bit, and this is -- there's not comparisons, but you asked the question. We have, obviously, CRB, CUK, SBS and the categories I was just talking about. URB, while a very good substrate, it participates in the industrial side of packaging much more so, tubes, cores and the like. So it has market participation that looks more like that, and you've seen some of the slowing there. And I think that -- and we don't produce URB. We consume very modest quantities of it that we acquire. And then to the other side, the corrugated side there, I think you're really managing through a much more distributed business when it comes to consumer discretionary and nondiscretionary. You don't need your second Peloton bike probably given the good shape you're in. But did the -- yes, how do you like that? But the reality -- but boy...

That could be used, looked at -- you're trying to influence me, Steve, there.

I'm sorry. But you don't need your second Peloton bike. And so that side of the discretionary spend and the industrial spend. And so I think there's -- where we are, which is what we're focused in on, the demand profile is maintaining itself quite positively.

Thanks, Steve. Any questions from the audience for Steve? If you can just wait for the microphone? Thanks, Linda.

Yes. You mentioned organic growth quite a bit. I'm just trying to understand what you mean by this. A comparable sales growth? Where do acquisitions play in your growth forecast?

Yes. Thank you for that, and thanks for asking because it helps to distinguish. It excludes acquisitions. So when we acquire a business, we count those earnings separately in their entirety. We also exclude price. And so it's actually a very pure definition of real top line and then, of course, earnings real top line growth that's driven by new-to-the-market products that we can lay eyes on and it is no price, no acquisitions. It's just true organic sales. And as I mentioned earlier, it's -- we kind of -- we identify it very specifically.

So would you care to expand on what your revenue targets might be?

Well, as we were talking earlier, I think for this year, we will continue to see -- we expect 100 to 200 basis points of organic sales growth. That on top of a positive price momentum that we have in the business of, I think, $400 million to $500 million kind of moves us from the $9.4 billion that we were last year into the -- modestly above $10 billion this year, excluding any to be activities acquisition wise, but we don't have anything that we're talking about here today other than what we announced, which was a small acquisition of the Tama CRB mill that we completed in January. So anytime you see our waterfalls, if you will, you'll see them in exactly that category, price, volume mix. You'll be -- we talked about acquisition top line separately, and it's not in the organic sales calculation.

So onto capacity. Why should investors -- and you talked about this, but why should we view Waco as the right next step for Graphic, even though the returns on paper look to be lower than what you saw with Kalamazoo? And when -- why does this make Graphic a more highly returning company, longer term?

Yes. No, and thanks for asking that. I think for one just point of clarity when we initially announced Kalamazoo, which I think was your reference point, we said we'd spend $600 million and get $100 million of EBITDA. When the project was completed, we said $130 million of EBITDA. We'd spent -- we had spent $700 million. And then this is spend $1 billion, get $160 million. So the initial Kalamazoo investment and this investment are actually very similar in their return profile. And what we're really doing here is focused in on what we know is going to happen with Waco. And what I mean by that is, it's very clear what the fixed cost reduction is from closing higher-cost facilities, what the variable cost reductions are from having very efficient paper making -- paperboard making capabilities and then optimizing what will be a 6-mill system. So the $160 million, we've got clear line of sight to, we'll, of course, refine that over the next couple of years. But I think you would agree that I clearly defined doesn't require growth of any substance investment where you can get 11%, 12% returns at a competitive distinctive advantage for the next 30 years is one you do. And we believe the outcome of that will be the lowest cost, highest quality network of paperboard that supports the packaging company that we are, and it also allows us to support 100 to 200 basis points of growth for the foreseeable future. One point of clarity, too, that's come up quite a bit that we didn't convey necessarily when we announced it, we expect capital spending to be at 7% to 8% of sales for about a 3-year period. And then it's going to drop down into that 5% of sales ZIP code in 2026 and beyond because we will have optimized the system that we have to support our consumer packaging business. And that's a good thing because it obviously -- and we can support the volumetric growth that we expect to see over that period of time.

Steve, I mean one thing, right, your middle name is Packaging, right? And so one of the moats that you've got relative to other companies that might consider coming into the market is that. Yet you did Waco, which is more a paperboard. What are you doing to build the moat on converting, which Staphos newsprint that now decides it wants to get into Staphos paperboard can't do or you don't need to worry about me because I don't know what I'm doing in packaging anyway and better to lower the cost profile out of Waco?

Yes. No, you're absolutely. I think the great thing about Waco is that it's highly supportive of building out the integrated company that we are. We are confident now that we've made the Kalamazoo investment that over time, the world's lowest cost, highest quality CRB is going to actually win in more places than it has historically, which supports the 100 to 200 basis points of organic sales growth. And today, coming out of 2022, 73% of all the paperboard we produce got turned into an end package, 85% of our top line did. And so as we continue to grow organically 100 to 200 basis points and have the balance sheet to continue to do some tuck-under acquisitions to support integration. Our integration rates will move to maybe 90% over the next several years, which really puts us in a very strong position to continue to retain the relationships and grow the relationships that we have with our customers. Because I mentioned earlier, our customers are the CPGs. Other participants may just make paperboard and then have to work through the network of independent converters and then selling to the CPGs. Our relationships are with them. And today, when we're renegotiating our 2- to 4-year contracts with our customers with the Kellogg's, Anheuser-Busch, the others, we're having that initial discussion is so often around assurance of supply, is can you supply me? Are you going to be able to weather storms and give us what we want at the quality level on time, in full? And our network and our track record of being able to do that is very, very good, and it's one of the walls in the moat, if you will, that we're building up around the company.

Pushing back on that, not that I disagree, but -- there is at least a couple new machines coming on -- converted machines, I guess, I should say, by mid-decade. So one could argue is there going to be plenty of supply and less concern about surety. How do you answer that?

Well, it's only half the answer because bringing on paperboard doesn't bring on a package. And so I think you raised a very important distinction. And listen, we're -- we operate in a highly competitive environment. And as paperboard -- additional incremental paperboard comes into a growing market over the -- probably in the 2026 time horizon, there'll be an appropriate need for it. But you've only answered half the equation. So you have to not only produce the paperboard, but it has to have -- go into the hands of a converter who can put, turn it into the package that the CPG wants. And today, we have those relationships. Those will have to be nurtured and built by those that are looking to make or contemplating making those investments. And listen, we don't underestimate those investments at all. That's why we're -- as you've seen us doing, we're playing a lot of offense and a lot of defense as good teams do to really create the business that is the consumer packaging business that we have.

Steve, if you mentioned, I forget. How much of Waco actually is around freeing up bleached capacity or virgin capacity since so much, again, of the growth has been in fast-moving, more food service-oriented products, and Waco is obviously CRB? So help me square that circle.

Yes, I think the way to think about that is, today, over the last 3 years, the 3% organic sales growth has been broad-based. So it's been across CRB, CUK, SBS, that's good. We expect that to continue to be the case. Critical to your question is, when Waco is done, we will have 6 mills, low-cost, highest quality that we can actually manage across that network to move on the edges things around so that we're optimizing the whole. So if we need more products that would historically have been in SBS, do we need to move someone into from CUK over into that product category? So that optimization of this 4.4 million ton network is really a value creator for us by having all 3 substrates at a cost and quality advantage net.

This is an oversimplification, but what could that ability to optimize further add to your ability to swing and grade shift? Is it a few hundred thousand tons?

Yes, it tends to be on the edges of those. In other words, that -- because to your fit-for-purpose discussion earlier, there are certain things that are always going to be in a certain substrate. But on the edges of them, at a couple of hundred thousand ton edges of each of them, there is opportunity to optimize and move. And you saw us do that when the unfortunate realities of COVID hit, and we saw this massive movement to the home and away from food service, we actually moved a fair amount of SBS need -- or excuse me, CUK demand into SBS to service that. And we're uniquely positioned to be able to do so. Now I don't see anything of that or want to see anything that radical as we saw with COVID, but we're prepared to handle that.

And the potential FBB line in Augusta and Texarkana, and that swing capacity, those back burner right now?

Yes, they are. They're great projects. We talked about them openly as we always do to try to be very transparent on things we're assessing. Good news is they're good projects. They're just -- they don't need to be priority projects for us here in the short to medium term as we really, over the last several years, assessed where is the best place to go. We obviously reached the Waco decision as the highest return and best long -- both medium and long-term investment for the business.

So let's wave a wand, it's now 2026. Stock is at $100, just -- who knows, we'll see.

Absolutely.

Take that from the question. It's back to 2026. And how is the strategy on capital allocation changing in terms of how you drive return for your shareholders?

Yes. Well, I think it's a great point. And I think as you move out to, let's call it, '26, '27, right, because at the end of '25, we'll have this large capital allocation behind us, the aperture just opens up here. In the next several years, we've got great capacity to continue to drive debt down into the 2.5x -- we're targeting 2.5x leverage by the end of this year. We are generating significant cash flow. We bring Waco to life. We continue to then have the margin profile and the cash flow generation to allocate capital in ways to drive the next generation of value creation. And so the tools, whether that's tuck-under acquisitions to really drive integration rates even further at that point to support the infrastructure or to -- obviously, on the -- there's the dividend, there's the share repurchases. So we really like the flexibility that we have even during this time of investment in Waco. I don't want to underestimate that because we're still generating very significant cash flow while we shape the next 30 years with CRB. But I think you're going to see us continue to have those tools readily available.

I mean, just probably overly simplistically, isn't it, by that point in time, it becomes much more of an inorganic strategy or strategy below the line where -- you've got your paperboard, you've probably built your converting moat, and now it's about either taking -- buying stock back, increasing returns through the dividend or buying stuff?

And supporting the organic sales growth, and -- but -- yes.

Well, you will have already done that.

Yes. Well, there's -- yes, just got in supporting it. But no, listen, George, I agree with you. I think that the flexibility that we have to invest for the next decade is high. And this attachment to the consumer is critical to that.

Thanks, Steve. Any -- Rob, quick one as we're at the end. Wait for the mic. Sorry, Rob.

Just a quick one. Waco sounds like quite an exciting investment, particularly with the success at Kalamazoo. Congrats on that. I'm just curious, when we think about the Vision '25 targets, does that become a little bit of a stretch goal in light of the fact that the EBITDA uplift is more '26 and perhaps some of that capital have been earmarked for bolt-ons so maybe there is a little less capital there. And tied to that, I'm just curious what you're seeing on small tuck-ins is the opportunity set that you're looking at there?

Yes, thanks for that. And I think for -- just for clarity there, I think we're really pleased that we're on the verge of achieving some of our Vision 2025 goals in 2023. And so much of what's in 2025 is still in sight as we look, even though now we're investing with 2026 and beyond. And so one of the things that we are talking about is, when is Vision 2030, the right conversation to be having because we are -- we have investments now that take us into '26 and beyond. And so -- and the second question, say that again, it was...

Well, just the [indiscernible] bolt-on acquisition in 2025. It was a little less now with Waco and [indiscernible].

Yes. I think there's still tuck-under opportunities that exist in the context of what we're discussing here. I think if you talk integration rates between here and 2025, organic sales growth gets us into the -- probably the 80% range as you grow organically and then kind of leaning up towards 90% does require some of the tuck-unders over the next few years. And horsepower is good. I mean, at 2.5x lever, there's still the potential when there's buyers and sellers for tuck-unders to make good sense from an integration perspective.

Thanks, Steve. Rob, thank you. Everyone, please join me in thanking Graphic Packaging and Steve Scherger for a brief presentation.

Thanks, George.