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

All right, guys, I'm Phil Ng, Jefferies, paper and packaging analyst. We're delighted to have the Graphic Packaging team here. Representing the company, we've got Mike Doss, CEO of the company; and Melanie, who heads up the IR efforts. I'm sure you've all spoken to.

Well, Mike, I guess, to kind of kick things off, there are some exciting M&A news potentially in the paper packaging space, particularly on boxboard with Smurfit coming potentially into the U.S. market. Any thoughts on what that could mean for the broader industry and yourself?

Well, you know when I jumped on the plane this morning. I was a little worried there would be no one in the room and I'm feeling a little bit like a down ballot candidate, pulling at 2%. So I'm thrilled to see everybody out here today, and thank you for your interest in Graphic Packaging. Yes, we read that yesterday as well when it started to break after hours, I think The Wall Street Journal reported on it first, and there's been a number of Ks filed here on that. Look, we don't know any more than you know at this time. And so we're going to have to wait and see if something actually transpires there.

What about having a new competitor come in? They're not very big in boxboard, right?

No. They don't do much in boxboard in Europe. They've got a little box board business in Central America that they operate. So again, I just don't know enough to comment intelligently on it.

Okay. Well, maybe I should not focus on that. Well, let's pivot on to the sustainability growth story that is really exciting about Graphic going forward. I've seen some news that is looking to transition away from the plastic ring callers. Is that a win for you? Certainly, that's another example of that sustainability pivot, but help us think through what that opportunity could be for you guys going forward and how to position.

Yes. Thanks for the question there. I mean, look, this is an ongoing process that we've been on this journey now for a number of years. A couple of years back, we came out with our KeelClip, and we placed over 50 machines in Europe and a couple of them in North America already with that technology. So I see this as a continuation there and a validation of kind of the momentum that we've been talking about with investors that this pivot to more circular economy, more sustainable packaging is real and that fiber-based consumer packaging in particular, which is really all we do is going to win around the margin. And this is a great example of that. And our share of beverage globally is over 60% of all the beverage fiber-based packages. And so as they continue to make that transition, we expect to participate in that process with them in a meaningful way.

Great.

And I think if I could, it just further validates the confidence that investors should have in this 100 to 200 basis points that we've been talking about for growth. It's -- these are base hits as they continue to come in, but they're measurable, whether it's foam to paper cups, and we talked about our Chipotle trials underway there, too. Now Pepsi making this broad-based announcement, Pepsi makes that conversion in North America, it's 70,000, 80,000 tons of paperboard that are required to do that. So these are important proof points, I think, for investors that this particular type of packaging that we make is going to be a winner with the move towards a more sustainable economy.

Great. There's been a little noise on the demand front for you guys with consumers and CPG companies going through some destocking. Any update on that front and how your demand is trending in your quarter, orders and whatnot?

Yes. So yes, we talked about that in our second quarter call. We had a 3-year stack of over 10% volumetric gain as we looked at 2021, '22. So if you look at that a little over 3% a year, this year, we grew a little bit in Q1. Second quarter, as you saw, was down around 4%. We said Q3 would be similar. It's tracking at that kind of level. And it's against a difficult comp. We grew 5% in Q3 of last year. Q4 last year was about 1%. So we still believe that we'll be able to grow modestly in our Q4. Most of destocking in our opinion is behind us. As many of our customers are wrestling with the question around how to deal with the elasticity of their products and the pricing that they talked during the run-up of inflation and the supply chain disruptions there. But we are seeing green shoots, some green shoots, I should say, around promotional activity. Melanie was talking to me on the flight up. She was at the store yesterday where a lot of buy 1 get 1 frees. I think our customers are going to look pretty hard at how do they not take any reduction in price, but they still get the volume moves that they need to get. As you know, that's important for their stocks, and I expect that they'll be spending a lot of time in the fourth quarter this year and into 2024, figuring out just how to do that. So our foodservice business has remained very vibrant, very solid. You'd expect it to be with unemployment in North America around 3.8%. So the consumer is mobile, they like convenience, they're busy. And we've really been crushing it with our foodservice business here since we acquired that business.

I was just curious, how do you think your business would hold up in a moderate recession? And frankly, Mike, I would argue that the packaging space more broadly has gone through a recession the last 12 to 18 months is because of destocking and the consumer dealing with a lot of inflation and perhaps maybe now that we're in toward an endemic rather a pandemic away from home consumption is really dialed up. So in a softer macro backdrop, how do you think that all plays out?

Yes. So if you think destocking and you just look at kind of an algorithm between packaging sales and CPG sales over a 2-year period of time, it was a little over 3% that was kind of built higher. So the destocking kind of clears that out and what you'd expect then as you go into fourth quarter in 2024 as our volume should behave much more closely with what consumer product goods companies, your sales are tracking at because that inventory has been burned out of the system, out of the supply chain, if you will. I would also agree with you that volumetrically, I think packaging companies have been dealing with a bit of a modest recession here. And it behaved that way, too, where we've seen some deflationary aspects of some of the input costs that we purchase as well. I think the oddity in this one is just the vibrancy of the U.S. consumer, in particular, with 3.8% unemployment. Anybody who wants a jobs got one, that's a good thing, and really the products that we make are nondiscretionary in nature. People need to eat and drink. 90% of everything we do falls in that category, whether it's mobile, on the move away from home or at home, those are the products that we make. So we really like our diverse customer portfolio and expect we'll continue to have momentum as we go into 2024. There's a slide in the back of the deck that's out there if you want to see how we performed in 2008, 2009. It will give you some insight. Our volumes are down around 3.8%. That might sound familiar given what we've just been talking about here and our margins expanded, we generated more cash flow. And of course, we're a much different company than we were then. We were levered at 7x in that environment, and we'll finish this year somewhere around probably 2.5 or 2.6 depending on when we are able to close the Bell transaction that we announced on our second quarter call, which we're really excited about, by the way.

So Mike, like you pointed out during the financial crisis, you were a very different company. Give us a little flavor on how you guys are better positioned to navigate potentially a modern recession?

No, look, our customer portfolio is just so different than it was then. I mean, our top 25 accounts were 80% of our sales, which is nice from an SG&A standpoint. But if one of those customers got cold, we got the flu. Now if you take a look at our top 25 accounts, it's below 45% of our overall volume. We didn't even have a foodservice business back then. We didn't have SBS as part of our portfolio, so we couldn't balance the substrates across one another like we can now. And of course, just having revenues and cash flow that are associated with a $10 billion company versus at that time, basically about a $4 billion company. It's just a whole different set of dynamics. So we're well positioned to be able to weather whatever comes our way.

Okay. Boxboard prices have been obviously quite robust the last few years. So it's not a terrible surprise we're seeing some pullback here. We've seen New and WestRock take a decent amount of downtime and committed to managing supply and demand. But RISI obviously lowered SBS prices recently. You gave us a little flavor on, one, it's often backwards looking. But give us a little flavor in what you're seeing in the marketplace, where you're seeing some of the competition? And how do you kind of think about boxboard prices kind of holding out this year?

There's really one substrate that's seeing the pressure, and that's coated SBS. And I have to remind investors here a little bit of the math. We make 1.2 million tons of coated and uncoated SBS. 400,000 of the tons we make are uncoated SBS and that's for our cupstock business, which, as I mentioned earlier, is growing, and there's been really no reductions in any of the pricing associated with that because demand is solid. So that leaves 800,000 tons of capacity on coated, which is a little less than 20% of all the tons that we make. So it's meaningful for us but not material if you think about what it looks like relative to the overall profile of the company. We have taken and publicly talked about the fact around 100,000 tons of market-related downtime through the end of July. And we're very committed to continue to match our supply and our demand. There's really no sense in us making a ton, we don't have sold either to ourselves or to a long-term customer on our open market side. So you can expect us to continue to be very disciplined along those lines, and we will do so.

When you look at all your different grades and, markets, maybe you can comment on perhaps, is SBS the one market that was a little more [indiscernible] levers, let's say, CRB, CUK a little more flavor on that.

Our CRB, our CUK business, those are solid businesses. We're running those mills steady. I think the other thing you should realize relative to what our strategy is on SBS is we're going to grow our cup business, which means we're going to need more uncoated cup stock. And so our approach is to convert more and more of our coated SBS into uncoated SBS, which is integrated into our cup operations. And so we've got a strategy and a plan to be able to do that. And then over time, we'll just reduce our exposure to the open market sales of SBS -- coated SBS, I should say, Phil.

Okay. Super. On the last earnings call, I think Steve gave us an early look for 2024 in terms of price cost being a fairly neutral to positive. So if you kind of unpack some of the levers that you have at your disposal, it kind of implied that EBITDA would be flat to maybe up in 2024. Is that still a realistic target at this point just given some of the movement in SBS prices?

Yes. Look, it's early September. So there's a lot of time between now and then. But if you just -- to use your word on pack a little bit about what we talked about there. So the midpoint of our guidance for 2023 is $1.9 billion. We have announced the deal with Bell Packaging said that was going to generate an incremental $30 million of EBITDA with $10 million of synergies, so a total of $40 million. We expect that we should be able to close that relatively soon. And so you get a full run rate on that and probably the synergies next year as well. Price/cost is probably just modestly down right now with the recent RISI moves. We've got some resets of some contracts that are actually on the positive side there, as we talked about on the call. And then we've taken a lot of downtime this year to match our supply and our demand. And so what I would expect as we move back into a growth mode again, volumetrically, we grow our 100 to 200 basis points in 2024. We'll harvest some of that productivity that right now this year has worked against us. So you put that all together, Phil, you add it up, we'd expect to see growth of EBITDA next year, modest. But based on everything we're seeing right now, we build on our 1.9 billion.

Okay. That's great. Certainly, there's some concerns about supply/demand, and we look out to 2025 and beyond. But would you help to understand how you're positioned versus some of your competitors are not vertically integrated especially the [Safes] and [Billeruds] of the world. And how are you going to be stacked up from a cost curve standpoint?

Yes. So a couple of things that I think we should think about there. First, the world changes and moves pretty quickly as we saw yesterday with a couple of pretty big announcements. And so a lot of things can happen between now and then. There is no new capacity in our market coming online before the end of 2025, so call it 2026 and that would be Safes startup and our start-up in Waco. Of course, we'll manage our start-up in Waco quite intelligently. We've got some mills, higher cost mills that will go down as we ramp that mill up, we'll be very thoughtful in terms of how we do that. So that won't be an issue. Relative to other capacity that comes online, we've been asked a lot about Billerud, I just don't know what they're going to do. I mean they said again, there'll be an update here towards the end of the year. If they do decide to do something even then, you're looking probably 3 years out before you see any tonnage that comes online, it takes a while to order the machinery, install it, get it operational. And of course, we're continuing to build the company, get stronger, drive our integration rates up, drive our top line up, delever the balance sheet and improve the overall business. We're not going to stand still. So I like our relative positioning here over the next 2, 3 years because there isn't a lot that's going to be in our way.

Are you doing anything on the contract front, locking up some of these customers longer term?

A little bit. We're looking at it, but we don't want to give anything away, we don't need to because again, you've got to get -- it's one thing to be able to get paperboard. It's another thing to actually get cartons, and we sell them to customers, cartons and cups, and we've got the lowest cost and most geographic dispersed converting network in North America and in Europe. So that's how we're running the company. It's really a packaging company. Sometimes we spend a lot of time talking around the paperboard and I get it. It's on investors' minds. But really, the strategy is to grow the packaging and cup sales here 100 to 200 basis points and pull that material through our low-cost mills that we integrate on our own because we make good returns on that, as you know. So that's how I think we should think about the business.

As you pull more of that demand for your cups business, is there an investment we need to make to kind of unlock more converting capacity on the cupside? Are there any real...

It's all within -- as you kind of think about your models, we're going to have elevated CapEx between now and 2025 as we build out Waco as we've kind of already taken everybody through that. Then you're going to see our CapEx as a percentage of sales revert back to 5% or below of sales. And that's still a very healthy number, and that will more than allow us to drive the type of productivity we need to drive. We're not going to need to do a big investment into converting that's going to be above and beyond that. We've done a nice job keeping our fleet up to speed, investing in our lowest cost assets over a multiple years and then shutting down the high-cost ones when they are no longer viable for us. So yes, that's, I think, another real great thing about where the business is going to be positioned. We'll wind up with 6 very well-capitalized low-cost mills when Waco is operational, very low-cost converting platform, excellent customer relationships and contracts. So that's where Graphic Packaging is heading with our strategy. And I'm really excited here to be working on our Vision 2030. Many of you know, we laid out our Vision 2025 in the fall of 2019. We'll achieve most of those financial goals actually this year. So a couple of years ahead of time. And we're working with our Board right now and our Vision 2030 and probably be in a position to roll that out externally sometime early next year. So that's where our focus is.

Super. You're planning that far out.

Yes. Well, it's important to do so because these are long-term capital allocations, and you need to make sure you get the strategy right. And one thing about Graphic Packaging. We've got a strategy, and we keep reinforcing it, keep executing. We don't change course here over time. So at least not without reason.

Well, Mike, since you're planning on your 2030 strategy going forward. You guys have done a phenomenal job in unlocking cost out productivity. Is that run rate still a good way to think about it? You guys have done extracted a lot of the last about 10 years.

Oh, yes. Look, I think, look, Waco is a separate allocation and we said, you can write down $80 million in 2026 and $80 million in 2027. So we need to deliver that to shareholders because we're spending $1 billion on that project, and we will. Just like we did in Kalamazoo, we actually got it a year early, as you know, and got a little more. So our confidence level is high that we can do that. But yes, cost out, that's a big part of our DNA. We've got to make sure every year we offset our labor and benefit inflation. This year was kind of a high watermark for certain other costs like insurance and some of the other things that were just kind of onetime resets given some of the things that are going on in the market. So we're off a little bit this year in terms of offsetting it completely. But I expect that we'll be able to do that again as we roll out of '23 and '24. Volume will certainly help us if we're running the mills full and we'll pick up all that -- all those underabsorbed fixed costs that we had this year that we won't have next year.

Okay. Just given your strong free cash flow profile, you should bring your leverage down pretty meaningfully by this year-end. At that point, I think you're pretty much at your leverage target. So how should we think about your capital deployment priorities between paying down more debt, buybacks and M&A?

All of them. All of the above. I mean -- and we've done all the above. I mean, I think, look, we'll look for how to best utilize a strong free cash flow position that we're going to have. To your point, we'll be down 2.5%, 2.6%, depending on when we close the Bell transaction here at the -- at year-end. That's phenomenal. We haven't been there since 2016. We're a much bigger company now. And so we've got a -- next year is a heavy CapEx year. We've got to be smart about how we kind of manage through that as we get Waco up and going. '25 will ramp down a little bit, still be above that 5% target I talked about, but then we will ramp down in 2026 meaningfully and the cash flow generation will be quite large. And so, yes, you can expect that we'll continue to be opportunistic in terms of share repurchases. We've increased our dividend last year. We'll continue to look at that with the Board. We'll do smart M&A, but that will be balanced against share buybacks and relative returns that we're getting in an interest rate environment that we've got right now. So I like the fact that we're going to have our debt down to 2.5. And look, if we went down to 2 for a little while here and kept our powder dry for something that's out there. There's a lot of things going on. As we talked about earlier here, maybe there's some opportunities for Graphic, and we'll be able to execute on those if they are.

That's great. Can you give us a little perspective on Europe. Your business is hanging in there actually really, really well versus the broader market and maybe some of your European peers that are vertically integrated. What is Graphic doing right? And how do you kind of see that outlook in call it medium term?

Well, being nonintegrated in Europe right now is a really good thing, particularly being a large buyer of paperboard in Europe, which we are, maybe the largest. So it gives us a pretty big lever to pull, and we pulled on it hard. Our volumes have held up reasonably well in that macro, in that geography, I should say, because it is a tough macro. I mean there's inflation. It's pretty significant in Europe. As all of you know, there are supply chains that are just being reset with the sanctions, given Russia's invasion of Ukraine and the war that's going on there. So a lot of dislocation, but dislocation brings opportunity for us. My team on the ground there is executing incredibly well. They've done a great job positioning that business, delivering on the synergies and finding ways to grow. And I'm excited about our prospects into 2024 as well. And yes, strategic, we always said, maybe we backward integrate in Europe, but it's not a strategic imperative for the near-term future, maybe the medium-term future with all that's going on over there, it seems like a nice business to have from an ROIC standpoint not having those assets that we have to worry about.

Once again, it feels like you're taking share. What's driving some of that dynamic versus...

It's the investment. I mean you look at our company, we've invested significantly for a competitive advantage. The quality, the cost structure we have in this company, we can go toe to toe with anybody. And I would say some of the things that are going on in the marketplace are probably a function of some of the things we've done in terms of relative competitive positioning. So we do have a value offering for your customers that's unique and different. We back it up. We're very consistent. They understand how we're going to operate. And that's really important in terms of them being able to manage their brands because the worst thing they can have is some kind of variation where they don't get what they need, and they got a stock outage or we can't deliver on some of the commitments we made around the economics of a package. They can count on a Graphic Packaging. And then we've got long-term relationships with the largest CPGs in the world and we do business with them every day, and they're appreciative of the fact we're investing is heavily back into the business as we are.

That's great. So you commented earlier, it feels like destocking is largely winding down at this point. Any more color in terms of what are you seeing between end markets, private label, beer versus food, food service? I mean certainly, there's been some dislocation with the biggest brewer country. So just help us unpack some of the nuances between all these different end markets that you're seeing.

Certainly, more of a focus right now on value. There's -- and that shouldn't be a surprise to anybody. I mean stores like Walmart, The Great Value brand, they just reported their results. They had an excellent quarter in terms of grocery sales, that shouldn't be a surprise. Costco also with the Kirkland brand. These are brands that are very large when you take them even individually, and you'd expect them to win in this kind of environment. We're seeing that. We participate in that sector at scale, and they talked about it on their earnings call. So you guys have already seen that. But yes, I'd expect that to continue to be the case. But on the other side, the branded teams, they're finding ways to reposition their brands. It's been a tough slog for all of us because we had to offset all that inflation. You work so hard to get your pricing up. You got to be real smart on how you work your promotional activities, but I'm confident they'll do that, and we'll see a return to growth year as we inflect into 2024.

And from a private level mix dynamic, how does that impact your business margin-wise?

We're a bit agnostic because we participated share on both branded and at the private label. So it's basically moves to one side of the equation or the other. And that's purposeful. We built the business to be able to do that. That was another difference from 2008, 2009. We did not have a material presence in the store brand or private label side of the business. Now we do.

Okay. Mike, anything I'm missing that you want or maybe perhaps the investment community underappreciates the Graphic story.

I don't think it's an underappreciation, I think if I have 33 seconds here, I would just give a little plug to our PaceSetter Rainier paperboard that the new grade that we've got coming out of Kalamazoo and we'll be able to make it in Waco as well. I was there earlier this week to quality and basically, the appearance and the smoothness, if you look at that sheet, it will rival anything we're doing on our coated SBS side, but the equation, as I mentioned, we're making a pivot out of coated SBS and into more uncoated cup stock. This particular board is able to compete with that substrate and it's able to do it at a significant cost advantage. So we like the positioning. We got a lot of trials going on with customers. I think it's going to be a real winner for us. So keep an eye on for that. Keep asking questions about that one.

That sounds good.

Thank you. Appreciate all the interest today. Thank you for coming.