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

Good morning. I'm Sam Darkatsh. On behalf of Raymond James, we'd like to welcome you to the Graphic Packaging presentation. With us today from the company, Steve Scherger, Chief Financial Officer; as well as Melanie Skijus, Investor Relations. Steve, I think you mentioned in your prepared remarks, call it, 20, 25 minutes or so, which will leave us maybe a couple of minutes for Q&A, but we also have a breakout session downstairs afterwards. So with that, Steve. Welcome.

Thanks, Sam. Appreciate that. I think you got me [ live and layered up. ] Can you hear me okay? Good morning, everybody, and thanks, Sam. Thanks for having us. Thanks for hosting Melanie as well. We're pleased to be here. And Talk a little bit about Graphic Packaging, give you a good sense for who we are as a company. Obviously, we'll be doing some forward-looking statements today, and all of you know what that means. And so we'll manage through that appropriately. When you stand back and talk about who we are at a glance. Graphic Packaging is a fiber-based consumer packaging company. That's what we do. We're making the packages that are in your lives every day from the paper cup that you're drinking out of right there. Thank you, sir, for doing. I appreciate that. To the cereal box that you may have consumed out of when you left home the other day or the 6 or 12 pack that you carry home or anything to the drive through. And we're in your life every day at the consumer level. We're just entirely committed to the consumer, entirely committed to fiber-based, fiber-based recyclable renewable. We topped through about $9.4 billion last year on our way to $10 million plus this year, and I'll take you through the economics a little bit later. But that is really the -- the who we are and obviously, a huge commitment to safety and -- and our 24,000-plus colleagues around the globe. We're a global company, again, entirely focused around the consumer, about 3/4 of the company in the Americas, most of that in North America. We've got very large and robust positions in our markets. And so in the markets that we choose to participate in, either #1 or #2 position, we expanded our position in the rest of the world, primarily U.K., Eastern Western Europe with an acquisition that I'll take you through back at the end of 2021, that is going extremely well and has expanded our footprint in Europe to a little over $2 billion. And you can see the manufacturing sites that we have locations, 100 plus around the world, making the end products. And that is really the focus of the company, as I mentioned a moment ago. We completed the AR packaging acquisition at the end of 2021, expanded our European footprint to about a $2 billion business, again, entirely focused on making the end products that we, as consumers, take home and off the shelves expanded our footprint quite nicely. eastern and Western European. As such, we're seeing very nice growth trajectory coming from that business. Obviously, the consumer is in a pretty challenging time but our overall volumes are holding up quite nicely, mostly because, again, we kind of operate in the nondiscretionary part of your lives, the day-to-day eating and drinking is kind of where we play. Very strong synergy capture and a growth opportunity for this business throughout Europe, we feel very good. It's the early days of consolidation in Europe relative to the world that we operate in, around fiber-based consumer packaging. We don't produce paperboard, the raw material in Europe. We send a fair amount of it to ourselves there. These are all end products that we're making, again, focused on the consumer packaging side. We're a very nicely distributed company when it comes to the markets that we participate in, the customers that we do business with. We are working with the world's small, medium and largest CPGs. It's across a very nice cross-section of food, beverage, foodservice, consumer packaging products and with the AR Packaging acquisition, also a new entry into the health care and beauty segments. We're just a very nicely distributed company. No customer is anywhere near 5% of the top line of the business. And it's very -- over the last several years with the acquisitions we've done, we've really kind of become consistent with -- kind of how we consume on a day-to-day basis, whether we're a private label buyer, whether we're a high-end food consumer, our participation strategies match up with that extremely well. And we tend to have, and we're selling the end products to the folks that you see there, these are long-standing relationships, tend to be multi-decade in their orientation. We obviously have to earn the right to grow with them every 2 or 3 years. It's a contractual business. Typically, we're in 2- to 4-year agreements with our customers. And as I know you can appreciate, assurance of supply has become an absolute imperative, particularly over the last couple of years. And we have the scale and the capability to service this great cross-section of CPGs in a way that allows them to make sure they've got assurance of supply for the packages, and I'll talk in a moment, helps us and them meet many of their circularity goals, ESG goals because of the role that we play, and I'll take you through that in a moment. But we're very pleased and proud of the distribution of the business. And again, it's entirely about the consumer and the day-to-day lives of consumers. We're a pretty unique company in that we really play right in the heart of the circular economy. We, with our business today, we have paperboard mills that make the paperboard and then we convert it, we turn it into the end products. We're uniquely positioned because -- and the mills are in the United States. We have the ability to make the paperboard the first time -- from a very well managed, sustainably managed for us. We produce what's called virgin paperboard or basically paperboard the first time. We make it the first time, turn it into that paper cup, turn it into that 6-pack or 12-pack. And then here in the United States, particularly throughout Europe as well, it's recycled. You put it into the recycling process, 60% to 80% of all fiber is reclaimed. It's found again. We then take it back into our coated recycled paperboard mills, and we make the product 5 to 7 more times, and we'll turn it into the cereal box or the Cake Mix Box or some of the other products that we make. So we're very uniquely positioned business in the circular economy because we've got a renewable resource in the forest. We make the product the first time, and then we reclaim it, get to make it over and over again. And it's uniquely positioned relative to our role in the -- in basically fiber-based packaging, the role that it plays in a circular economy as well as reducing food waste and other positives that come along with the role that we play as -- as a fiber-based packaging company. We identified back in September of 2019, we brought Vision 2025 to Life, which was a vision for the company to grow very materially, and I'll take you through our progress in a couple of moments. But at the time, we thought there was about a $5 billion market -- addressable market for growth for our business. Over the last few years with the acquisitions and with a lot of attention to what is possible, we now believe there's about a $12.5 billion addressable market for real innovation, real new-to-the-market products, new to the market relative to fiber-based solutions. The majority of it is plastic substitution in terms of where the majority of those opportunities have come from, very real, tangible identifiable products. Think about a 6-pack that used to have the plastic rings around it, it's now around the globe, moving to a package we call KeelClip, which is fiber-based, holds those 6 cans together in a very nice and circular way makes it a recyclable and renewable product. We continue to assess the size of the market. We try to make it extremely identifiable, real products, real solutions, real size as opposed to kind of a theoretical large opportunity. We tend to make it very specific. These trays, these bowls, these solutions, these kind of innovations and it's in the markets that we actively participate in today. Every year, of course, we have to be more productive and do better in terms of making our products the very highest quality at the lowest cost. We've got a long history of being highly productivity driven $50 million to $70 million a year of real cost improvement across the business. It's a bit of the history of the company. We've kind of got that very ingrained. We don't lose it, while we're also growing organically. And on the prior slide, that $12.5 billion addressable market for the last 3 years, we've been growing at 3% a year organically that excludes price, that excludes acquisitions. That's real new to the market growth. Our goals and aspirations are to consistently grow 100 to 200 basis points a year and then couple that with an ongoing strong stream of productivity initiatives that drive the business year in and year out. We made a pretty significant announcement along with our Q4 earnings. A few years back, we brought to life the world's lowest cost, highest quality coat -- coated recycled paperboard facility in Kalamazoo, Michigan. Brought it to life throughout 2022. It's a $700 million investment that will yield about $130 million of EBITDA improvement. We really like where that is taking us, and so we're going to do it again. We're putting a new facility into Waco, Texas. We'll put $1 billion to work over the next 3 years to dramatically alter the cost structure and the cost advantage and competitive advantages we will have in the production of coated recycled paperboard and then turning it into those end products that we were talking about a couple of moments ago. Great location in Waco. It's within 200 miles of 80% of the population of Texas. As you know, Texas is quite a growing population. It's got a great secondary fiber market. What that means is recycling. If you're going to make recycled paperboard, you have to be where the people are, because it's who we are, that generate the waste that we can then reclaim and take back to this facility and make the very high-quality coated recycled paperboard over and over again as we were just talking. We've just started construction. Everything is in place because we just did this investment a couple of years ago. It's a known investment, known technology. We've got great muscle memory on how to do it. High confidence in the returns that I'll talk about here in a moment, and it will come to life in early 2026, about a 3-year investment cycle, $1 billion about $300 million a year. I'll take you through the guidance here in a moment, but we can do that and still generate significant cash flow year in and year out. We'll have a very substantial cost and quality advantage. The dark green that you see there is once Waco is brought to life and then our Kalamazoo facility, and this is on a per ton basis but the cost to produce for us will have $135 a ton advantage over the entire industry. Most of the -- rest of the industry is older technology between 30 and a 100-plus year old technology, most of it is in the 30, 40 year range smaller facilities. And as part of this, we will close facilities. We have 3 facilities there: Middletown, East Angus and the Tama facility that we'll close. That's the assumption and so we'll bring on some modest net capacity to support our growth as a business, that 100 to 200 basis points of consistent growth and we'll do so by having the world's lowest cost, highest quality coated recycled paperboard. And we really like what we're seeing because making this very high-quality paperboard, we believe that there'll be more recycled packages in more places than it has historically been. And I'll give you an example of that here in just a moment. So a really compelling long-term competitive advantage, and we're uniquely positioned to make the investment that allows us to seize on that. When we're done with this kind of the core of the company, the making of the raw materials, the paperboard that we then convert into the end products that we then sell on to our -- on to our customers. When done, we produced about 4.2 million tons of paperboard today. Those are those 2 categories, making it the first time as virgin paperboard, you'll hear other words, SBS, U.K., those are like kind of the names of them and then CRB coated recycled paperboard. We will reduce our footprint down to 6 very well-capitalized, highest quality, lowest cost infrastructure to support what we do to support our ability to service you as consumers with the packages that we produce. And so as we'll close down the 3 facilities that are higher cost, and as I mentioned a moment ago, we'll migrate with a modest incremental capacity, a couple of hundred thousand tons across this infrastructure to support our growth. And what's great about this, too, is it gives us a lot of levers to pull if growth accelerates, we actually have some latent capacity. We can keep things open if we wanted to. If things go the other direction for some reason, we have the ability to tether that as well. So a lot of flexibility as you kind of look at this infrastructure, this very substantial infrastructure to support our ability to make consumer fiber-based packaging. We're doing a couple of things with this investment that are a little unique beyond what we did in Kalamazoo. One, for those that are looking at technical names, we're investing in a drum pulper. What that really means is that we will have the ability to take an increasingly large diversity of recycled fiber and turn it into the raw material capable of making that coated recycled paperboard product. And a good example of this, you can recycle your cups today. That cup is recyclable. There's just not enough of it happening. We're going to be -- have the ability to recycle up to 15 million cups a day beyond that, which is available today, which is what will happen probably throughout Texas and in the region and then expand out, is we will be able to take more and more of the raw materials that we need, well it's called OCC in terminology purposes, and put it to use. We're actually going to also take more of our own internally generated waste when you make a 6-pack or 12-pack, for example, you generate some waste that is part of the process. A lot of that today just leaves the country because it isn't being recycled, and we're going to actually be able to recapture it to increase recovery rates for fiber that's available here in the United States, we're going to put more and more of it to use as we build this out. We're also going to generate our own energy with the gas turbine investment that we're making. So we'll generate our own energy -- why important? One, obviously, consistency in terms of the runability of this facility, generating our own energy. But also, we're going to reduce absolute greenhouse gases by 12% across this platform, which is very significant. It's significant relative to our own role on the planet and our own role from an ESG and circularity perspective, real greenhouse gas reductions is something that's material and it's substantial. It also plays with our customers who are trying to meet their own sustainability commitments. In fiber-based solutions, lower greenhouse gases, it's part of -- literally from a circular economy perspective, all of us having a lower impact on the planet, year in, year out. This is a great investment that does that, and it does it in a material way. It will fit inside of our science-based targets that we'll be coming out with later this year in support of our circularity commitments. So exciting that in terms of some things we're doing in addition inside of -- inside of this investment. And the returns on it occasionally would be like, oh, gosh, really you're going to only get 11% to 12% returns? This is a 30-year investment and it's got absolute clarity of return, which is great. And the returns come from real fixed cost reductions and real variable cost reductions. We use less water. We use less coatings. You basically make a better product with less variable commodity utilization. We also are closing those 3 facilities. We get a significant reduction in the fixed cost to operate these facilities, and then we'll optimize that 6 mill system and obviously continue to grow at the 100 to 200 basis points. This is absolutely good clarity of return. Over the next 3 years, we'll continue to refine it. The Kalamazoo investment yielded a little higher return than this once we kind of got it dialed in. I kind of expect that to be the case here, too. But we've got great line of sight and $80 million of that will come in, in 2026 and the other $80 million will come in, in 2027. So good margin enhancing opportunity for us as we look out over the next several years. Financially, 2022 was a very good year for Graphic Packaging. Our top line grew over 30%. That combination of price execution to offset the realities of the inflationary environment that we've been working through, that 3% organic sales growth and a full year of the AR Packaging acquisition. So 30% top line, we leveraged it to 50% EBITDA growth, a little over $1 billion to $1.6 billion. Margins grew a couple of hundred basis points into the 17% range. EPS up very materially. That's an EPS, excluding amortization of the intangibles. A strong balance sheet. We ended the year 3.2x levered. We like to operate in the 2.5 to 3x range when we completed the AR Packaging acquisition, we were in the 4s. And so we literally took an entire turnout in 2022, as we generated the EBITDA, turned it into the cash flow and have left the balance sheet in a very strong position, great liquidity to do what we need to do. And that word integration rate there, that is the percentage of the paperboard that we produce, that we turn into the end product that we as consumers utilize. And that is the goal we have there to drive that 73% up towards 90%. To put it into context, 85% of our sales today are making this end product that, again, that is -- we as consumers are making full utilization. So a great year in 2022 and the momentum sets up for a very strong 2023. We have a lot of confidence in 2023. We brought the guidance out along with our Q4 earnings. As I mentioned, we'll probably pass through the $10 billion mark on the top line. Importantly, an EBITDA range of $1.7 billion to $1.9 billion that's a $200 million increase in EBITDA on a year-over-year basis at the midpoint. Strong confidence that we can continue. As such, margins will continue to grow. And as I mentioned, inside of that, even at spending kind of an incremental $300 million or so to march down the path of the Waco investment, we'll still generate $600 million to $800 million of cash flow. And as such, you can see our way to net leverage down in the 2.5x range from 3.2 at the end of 2022 and a continued strong advancement of adjusted EPS. So good, strong identifiable guidance or we're committed to it and our line of sight to it here early in the year is very good. It's all in the context, and I apologize for the numbers here, but it's in the context of the Vision 2025 goals that we established back in 2019 and then enhanced at the beginning of 2022. We actually increased the goals because of the progress that we've made. You can see there the progress from 2019, which is when we brought it to life with the '22 actuals and '23 guide, we're well on our way to many of the goals and aspirations that we identified several years ago. As I mentioned, top line moving from $6 billion a few years ago to $10 billion plus. Margins moving into the 18% range as we kind of march out of this year with aspirations towards 20%, we can see that over the next couple of years, very substantial adjusted EPS growth, the near tripling of that over this period of time in terms of out towards 2025. CapEx is going to be in that 7% to 8% of sales as we make the Waco investment, have every expectation, you go out to 2026. That will drop down to more normalized levels at about 5%. And so for kind of a long-term perspective on what it takes. And when we're done, as I mentioned, with this investment, these 6 incredibly well-capitalized mills will be able to sustain themselves very, very well at CapEx at those types of levels. ROIC moving from modestly above cost of capital to -- into the 10% to 12% range, line of sight to that, and then the integration rates. And in terms of how to get to 90% grow organically and continue to grow organically. And then over time, there's probably some tuck-under acquisitions in there as well that drive integration when we acquire businesses that are making the packages they helped to drive integration rates up us using more of our fiber to actually make the end products. And we're contemplating a move to investment grade. We are 1 notch below. We've been there by the design for quite some time. We now have the scale as well as the geographic distribution, the margins, the balance sheet to contemplate that. And it's something that we're working through this year. It's not an absolute, but it's something that we think we have earned the right to pursue that if we choose to pursue it. And so that's something that we're putting out there as well. So we're excited about the progress that we've made. We've had very good progress up until 2022. We're actually looking forward to the year we're in 2023, despite many of the challenges that are existing relative to. A little bit of heat on the consumer, mostly because we kind of operate on the nondiscretionary side of our lives. Most of what you do as a consumer is you're making your $5, $10, $15 decisions when you buy something that we've packaged as opposed to something that's a material investment that you would be making on a more discretionary basis. And so that's really the overview. I think I did that in -- roughly the time that you had in mind there, Sam. So I think that leaves us with a couple of minutes. So thanks, everybody.

Terrific. We have about 5 minutes for any questions in the room here? So when you originally talked about Kalamazoo, K2, the returns on that project at that time were projected to be that same kind of 11%, 12% or so that you're forecasting for Waco. And ultimately, those returns look like they're going to be more like mid- to high single -- mid to high teens. Give some similarities or maybe some differences between the 2 projects and what sort of circumstances might occur for Waco to have higher returns than you're originally forecasted?

Yes. No, thanks for that, Sam. I think we're -- and you're right, we've kind of -- when we announced Kalamazoo, you said it was right in the wheelhouse of the returns we just described, and we're operating several hundred basis points above that is our expectation. And we'll get the second tranche of EBITDA this year, one of the reasons our EBITDA is growing in '23 is because of Kalamazoo running at full speed and capabilities as we had expected it to. And it's going to be what you just talked about in terms of our confidence in the fixed cost reduction, variable cost reduction is exceptionally high. Where there will be upside, we believe, is in some of the incremental investments that we're making. The gas turbine, driving high efficiency day in and day out. I think there's upside to that. And this drum pulper, the ability to take a much wider variety of recycled content, basically, the raw material and putting it to work. We haven't really sized that yet in terms of what that is -- what that creates from what's possible perspective. I think it could lower the actual variable cost to bring those recycled fibers to bear and together and just ongoing and consistent growth. I mean as we continue to grow at 100 to 200 basis points fully expect this investment to come to life quickly with returns certainly at the level that we've described. And as we've mentioned over the next few years, when we see line of sight to it being potentially even higher, we'll bring that forward.

There's been a slow but steady conversion from plastic, more towards fiber. What areas of plastic conversion over the near to intermediate term are your biggest opportunities?

Yes. What's really good to see is it's nicely distributed across the market segments that we're participating in. So as opposed to it being a singular home run in baseball terms, it's a lot of singles and doubles. So we continue to see around the globe, more conversions out of either the plastic rings or a resin-based wrap around cans, bottles, et cetera, moving to fiber based. We continue to see wins like -- at the club store, Pepsi had a very large move last year out of large resin bag that you used at your Costco or your large shopping experience that held 30 of the snack bags for either yourself or your kids, they put that into a recycled box and it raised brand awareness, more recyclable and a big move as an example. We're going to continue to see moves from foam cups into fiber-based cups. So the food service side of the business will continue to grow. And the drive-through is winning as COVID kind of played itself out, less folks in the QSR is more driving through. That's a win for us because more of it is getting into packaging that tends to be fiber-based, more bowls, more trays, other containers moving to fiber based. Those are just good examples as we look out. So I expect it -- we expect it to continue to be a series of small wins that have accumulated up to the 3% over the last 3 years and 100 to 200 basis points going forward.

One of the common pushbacks is that there has been a lot of announced industry capacity additions at least over the next 3, 4 years or so, which has given some folks some concern. Why do you believe that the market can absorb these additions?

Yes. And very specifically, there's a couple of capacity announcements in the U.S. on the virgin paperboard side, SBS. Think about it as white on both sides for some of the packaging that we've described. Those couple of investments are announced kind of in motion, probably more around 2026 and beyond in terms of the timing. So we've got a good 3 years before advances. And in many ways, the business that we're building is the business that you've seen there. It's highly integrated. We make the end products that we, as consumers, utilize every day and bringing on just paperboard capacity doesn't make you a packager. You have to actually make the paperboard and then work with others who can then turn it into that that end package. So we like our competitive position. We like where we're positioned. We've got fantastic and long-term relationships with our customers. And over time, one, it's a growing market. And as we kind of grow into it, if you will, yes, there'll be some more capacity in '26 that might be needed in that moment. But in some ways, our expectation is that high cost will lose low-cost wins and there'll be some capacity that comes out of the market. And in fact, last night, a participants who makes SBS announced the closure of a mill and so 300,000 tons of SBS will be removed from this market over the -- by the middle of this year. It's a good example of, I think, just prudent and mindful supply/demand. And that over time, if you have a high cost paperboard mill, you make paperboard and you are high cost. Eventually, a capital call shows up where the cash flow generation just doesn't exist. And that was an example of 1 where the cash required to invest in and maintain it.