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

Good afternoon, everybody. My name is Matt Roberts. I'm the packaging analyst here at Raymond James. With us this afternoon is Graphic Packaging, a paperboard consumer packaging company that provides packaging solutions for food and beverage, food service, household and health care and beauty end markets. Many of their products you all use on a daily basis, probably not even knowing about it from paper-based coffee cups to the cereal boxes I eat my dinner out of, to innovative products such as 6-pack ring replacements or even cup noodles, which are now available in paperboard and microwavable for the first time. And I know you're all thinking, that's information that probably would have been useful in my college days, but they are indeed now microwavable for the first time. With us today is Steve Scherger, CFO. Also joining us is Melanie Sides, VP of Investor Relations. So Steve, thanks for joining.

Great to be here.

And perhaps if you could provide an overview of the company, just high level, why your customers choose graphic packaging and where your competitive advantages are?

I'd be glad to. And Matt, thanks for having us. Thanks, everybody, for joining here as well as online. You did a great job with that introduction. You actually gave a good sense for who we are as a consumer packaging company. We're a company that we are in your lives every day. And if we look on our purpose statements, I mean our purpose is to package everyday moments with the renewable future in mind because we are in all of our lives relative to where and how we eat, at home, on the go, how we drink, how we go through a drive-through, how we feed our pets, how we change our filter frames. And that's the business that really over the last 5 years, particularly that we've created has a business entirely focused on the consumer, entirely focused on generating products that are made from renewable resources as well as recycled resources and that are recyclable. And as such, that's really the business that we've created, top line of about a little over about $9.4 billion last year, about 20% EBITDA margins, good strong balance sheet. But if you -- why do our consumers work with us and our customers, why do they do business with us? We unveiled Vision 2030 a couple of weeks ago, and there were 4 pillars associated with that. And they line up really well with why our customers do business with us. One was innovation. We've got a great track record of creating new products. You touched on several of them in your opening commentary that are preferred by consumers and that help our customers win in the marketplace. So innovation, a real core attribute of what we have been creating particularly over the last several years. The planet, our customers do business with us because we're a very unique example of a company that actually is focused on a circular economy. We can invest behind that. We can invest to reduce our impact on the planet, invest to reduce greenhouse gases that helps our customers meet their sustainability goals and the expectations that they're sitting with us as consumers. We're also a business built around culture. Customers work with us because we've got a very deep, diverse, unique set of capabilities that help them win in the marketplace, whether it's through new innovation, high-quality products cost-effective solutions for them. And that, of course, all rolls through our 24,000 colleagues that make up the company. And then results. We are an important part of our customers' results. The products that we make, we make billions of them at times and they've got to run effectively. They've got to be very high quality. They have to work and it impacts them. It impacts their businesses, both in terms of how well they physically run, but more importantly, how the consumer reacts to the package when they take it off the shelf. And so we play a role in their results while obviously generating dollars.

Thank you for that, Steve. And you 2030 targets that you just presented a couple of weeks ago. So maybe can you just talk on how that builds upon what you accomplished in the Vision 2025 targets? And also how it represents a shift from Vision 2025.

Yes. No, it's an important question. And when we brought Vision 2025 to life back in September of 2019, in many ways, we were setting the stage for the investments that we felt were possible and important to scaling our company materially pivoting towards that consumer making a shift towards organic and innovation-oriented growth. We were very acquisitive during that period of time, 15 acquisitions that helped to build very intentionally the consumer packaging business that we've created. And it sets some aspirations in terms of the financial metrics. And we're very fortunate to achieve the majority of those by 2023, which really opened the door for us to bring Vision 2030 to life. The pillars I just mentioned are right at the core of it. And behind that is a financial model driven around confidence that we can consistently grow our top line low single digits through that innovation engine that I'm referencing as I mentioned a moment ago, that EBITDA dollars can grow consistently mid-single digits and have that in significant benefits from an EPS perspective. So it's a simple model, but it's a model that can generate very substantial returns in the form of above cost of capital returns because we invest behind the business to do so where we see real competitive advantage relative to the raw materials that we produce as well as the packaging that we produce for us eventually as consumers. And that has allowed us and allows for an incredible amount of cash flow generation. We're in the midst of a very substantial capital investment in the second new coated recycled paperboard manufacturing facility in Waco, Texas. We're putting $1 billion to work. As such, we're at a peak CapEx here in 2024. That will start to meter down in 2025 as we bring that facility to life. And then as we shared with Vision 2030, the cash flow generation of the of the business moves towards between $800 million and $1 billion plus as you look out over the next 5 to 7 years.

And you did touch briefly on the financial targets you laid as well. But could you maybe provide a little bit more color around the base business growth algorithm. What are your assumptions there? And should we think about that as an annual target or a CAGR over the period?

Yes. It's -- and I thank you for asking that. I think the low, mid-, high single digits, of course, there may be times where we're in an economic environment that creates a challenge there. So it's probably more of a CAGR, if you will. We expect to return to positive growth this year given the innovations that we know are active in the marketplace we, like everyone experience, some of the pretty well chronic destocking last year. For us, that wasn't as material as a lot of packaging companies just because our customers don't inventory a lot of our products, but we did experience some of it. But the algorithm actually sets up very nicely to grow consistently, mostly driven by our innovation, conversions into recyclable, renewable packaging out of other alternatives are identifiable and addressable market is very clear to us. We can see the packages that are in an alternative today a foam cup, for example, that we know can move to a paper cup over time. And so our line of sight to the innovation engine is quite good. We tend to be a business that grows more with population. So you put a little population growth on top of a -- an innovation engine that really allows for that low single-digit top line growth. And then when we and as we continue enormous emphasis around being highly productive, continuing to have productivity that offsets other costs in the business, have a model for being paid for the value of the products that we produce, steady and consistent EBITDA growth is there to be had as well. And as Waco, the significant investment comes to life, there will be value creation there as well. So that really allows us to have confidence that we can continue to operate the company in a very narrow band of EBITDA margins that over time can expand modestly. That's really how the model we see playing out over time.

Right, right. And you've spoken a lot about innovation already, and you have identified the $15 billion total addressable market from alternative products and 2 points per year from that. So maybe could you just give us some examples of those new products in the pipeline? And have you seen the pace of plastic substitution change over the years? Or how has that trended?

It's definitely accelerated over the last 3 to 4 years, and I think pretty well chronicled as to why. And there are plenty of packages that are appropriately in other alternatives. But when you look at where we have had success, what's great about it is it's very distributed. And so whether it's replacing a plastic ring for 6 cans that you may carry a round of carbonated or alcoholic cans that you may be consuming later today and putting that into a paperboard solution, it could be literally the cups that we talked about. We've got a very substantial initiative on replacing foam cups with our proprietary what's called a double wall cup, which is actually a couple we've invented that can sit in your car for hours with us in it, doesn't sweat, works as a foam cup does, even potentially a little bit better. And that's a great example of a major move. We're more involved in canisters than we've ever been before. As we think about it as the coffee or your Mentos gum, which was in a plastic container moving to a paperboard-based container. We've got a product called PaperSeal, which think of that as bowls and trays that are fiber-based that does have a seal on top of it, but it behaves extremely well around the perimeter of the store for meats and cheeses and other more fresh products. And so we shared at our Investor Day that we've gone from a company very much known, if you went back 2017 or beyond for making basically 12 packs and cereal boxes to one that now really participates in the totality of our lives, and we move with the consumer. If you have a bias towards branded products, we're intensely focused there. If you have a desire for more private label oriented, we're appropriately weighted there. If you're on the go consuming running through a drive-thru, we're there. If you're at home morning, noon and you cereal at night, perfect, we're there for you as well.

Good to know. And maybe new products aside, maybe you can talk about the underlying growth that you're seeing this quarter or '24. So more near term, what are you seeing in demand trends by each consumer segment?

Yes. We did definitely, like many businesses, for the first time in several years, last year, we had three quarters of negative with declining volumes. For us, it kind of started in Q2 a bit, accelerated a little bit in Q3 and Q4. And as I mentioned earlier, we're not a business that our customers carry a lot of inventory up. So it showed up a little late ended up being about a 4% destocking, we believe, if you kind of look inside the numbers for the year. And Q4 was particularly slow, and it was both in Europe and here in North America, kind of a real step back on order rates in -- between kind of the in the U.S. Thanksgiving holiday and in year-end. We've seen that move more towards normalized here as the year has kicked off more flattish. I'm not necessarily I think we'll be in a growth in Q1, but improvement over a minus 5%, which for us was pretty large in Q4. So normalizing, which was -- what that does is it gives us confidence that for the year, we can see a move back to positive organic sales growth. We've averaged across the 4 prior years, 2%. It was kind of in the 3s and then a little bit of the step back. So 2% is a good strong number, we believe, kind of normalized. We knows what the next normal is, but we're certainly in one that feels a little more normal currently. And the band around that is going to depend upon the assertiveness our customers have relative to promotions and the like. But we've got very good line of sight to the next $200 million of new-to-the-market innovation that we expect to earn on here in 2024.

Thank you for that. I will pause if anybody has a question, feel free to raise your hand. If not, we'll move right along. Right there.

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Yes. For us, most of our customers, we've got very long-standing relationships with. And most of them are in kind of 2- to 4-year contracts. So if you're a great long-standing customer of ours, every 3 years, plus or minus, we'll re-earn your business. Obviously, we operate in a competitive landscape, but we tend to hold on to or modestly increase our position with you, and that's how pricing is established on a value basis with you as a customer every few years. And then inside of that, we have a couple of different mechanisms for how prices change while we're in that contract. Some of them are more cost oriented. Some of them are more third-party index oriented. We've been moving away from those over the last several years. We'll continue to do that into the future. But -- so there are mechanisms for how prices move while we're in our relationship with you and then every few years, we'll re-earn it with you and make sure that we're getting paid appropriate value for the products. Our relationships with our customers are very long-standing and whether you're a small, medium or large customer of ours, they tend to be built for the long term. And our stability from a pricing quality, ability to produce at scale, particularly for our large customers, is really important because we've got to help them be successful in the marketplace with you as a consumer as well as just across their portfolio of their own assets. who are taking advantage of our packages that they're bringing to life for us as consumers.

Thank you for the question. Maybe if you could talk about how graphic is optimizing your manufacturing facility footprint. And what specific actions have you taken that should enable a higher ROIC?

Yes. I appreciate that. And one of the things we announced along with our Investor Day as we were unveiling Vision 2030 was a decision to enter into a sale of our Augusta bleached paperboard facility, which we acquired back in 2018 from International Paper as part of getting into the food service business. So think about that as making primarily the cups that we produce today. We took a decision that for us, it was not a manufacturing facility that drove competitive advantage for us as a business and actually fit very strategically well with Clearwater Paper who have a strategy of being an active participant in bleached paperboard production. And so we have entered into an agreement with them. It's obviously under the normal [ EOJ ] regulatory environment. We expected to close here in the second quarter, assuming everything progresses as expectations would be. What that's done is it actually takes about 600,000 tons of paperboard manufacturing capabilities out of our infrastructure and allows us to continue to invest back in elsewhere, where we choose to make our raw materials. So when we say paperboard manufacturing, that's us choosing to make the raw material that we produce to eventually make the packages. And post the sale of the Augusta facility, 95% of everything we do will be making an end product that you as a consumer interact with, a capable, a tray, a package. And so that's been a big part of the migration. Waco, when it comes to life, we'll bring on another 500,000, 550,000 tons of the world's lowest cost, highest quality recycled paperboard that we will then turn in to packages as well. And then as we've talked, there's about 300,000 tons of capacity that will go out. So you can work all the way through that over the next few years. we'll actually have a modestly smaller footprint when it comes to the paperboard that we choose to produce as part of having 95% of our top line of our sales be end products that we as consumers utilize every day.

Very helpful. And good capacity color there and what it does to your capacity output. But following the sale, are there near-term capacity pressures potentially as that goes over to Clearwater Paper or that's near term. And then longer term, there's been discussions of incremental capacity coming in. So if you could discuss, is the market capable of absorbing that? And how are you insulated from such risk?

Yes. I think first, I think it's important to note, as I just mentioned repeating, I mean, we're a consumer packaging company. So 95% of everything we do is making that package and we choose to make raw materials where we have competitive advantage, ROIC advantage, cost advantage. And then we buy paperboard around the world for the rest of our needs. And so the reality of that is that's the kind of the company that we've created. When it comes to the production of paperboard, there's some dynamics playing out a little bit of known us little bit of known capacity that's coming into the world of bleached paperboard, a little bit in North America, up in Maine, a little bit in Europe. Those are the 2 primary components where there is some bleach paperboard that's coming into this collective market. There's been some longer-term announcements. So I think one in particular Upper Peninsula of Michigan, I think, is unlikely to take place any time soon. So broadly speaking, the demand for paperboard-based packaging, I think we'll continue to grow, particularly here in North America and in Europe, where the consumer has a bias towards recyclable, renewable packages. So I think there will be a growth profile. Broadly speaking, for that, which we participate in. And then we've got our strategies for how we play there as a consumer packaging company.

That certainly makes sense. So if I could switch gears a little bit now to your free cash flow profile that you detailed 2 weeks ago, thoroughly. But -- so you outlined a path to cumulative $5 billion plus in free cash flow through 2030 million. What is within Graphics control versus what is demand dependent? And what underlies that base case scenario that you may out?

No, thank you, and you summarized it well. As I mentioned, we're in kind of a peak spend this year, probably $950 million or so on top of the $9 billion business. So a lot of cash flow, but we're still generating cash flow in the context of that, which is important relative to our ability to generate the kind of cash flow we'll still generate $400 million plus or minus of cash flow, while spending $950 million. And next year, in 2025, that number will step down. And then it will step down to 5% of sales for 2026 and beyond. That's plenty of capital for us, about 2% of sales for maintenance, 3% to grow and be more productive every year. So that's kind of the model for the business. As such, it does generate very substantial cash flow that we can put to work back into the business, our capital allocation components that we laid out included the potential for a steady and modestly increasing dividend as an example. -- appropriate balance sheet to fit the business we have pulled all of our investments up against repurchasing shares, repurchasing the company as we should, that's appropriate to do. And so we're looking forward actually to kind of the big investments that we've made, acquiring AR packaging in Europe, Kalamazoo coated recycled paperboard facility, Waco, the second one. I mean those are big, big investments that we've made that have created the opportunity to generate this kind of cash flow as we look out, and we're looking forward to obviously deploying that thoughtfully and creating real value from it with that much cash flow.

And you certainly have taken on a lot of projects. So are there any more in the pipeline?

Well, there's always projects in the pipeline. But I think what I would say and to get this question a lot is, is there a second or a third Waco or Kalamazoo and the answer is no. And you can write that down, no. And you can write that down, no. We're going to spend at 5%. It's an exceptional place to be. It allows us to invest for growth in the business. And as we stand back from the business, that will be post the Augusta sale of that manufacturing facility. We have the business in hand and in place that can actually grow low, mid- and high single digits. And of course, with that level of cash flow that comes back into the business after executing on that algorithm, it really opens the door nicely now. We put that back to work to create value. But there doesn't -- the good news, and we've assessed that every way conceivable is there's no need for that next major investment. There will be CapEx of substance, and we'll do some things that were going to reduce greenhouse gases substantially over the next decade, and that will require some meaningful capital investments, I think recovery boilers and the like and our wood fiber paperboard facilities, but they'll be metering in over time that allows us to put that kind of money to work. We'll make big investments in automated warehouses as an example, big meaning a $100 million kind of thing. But it's all in the context of 5%. And so there isn't the next that's out there.

What about on the M&A side? If the market outlook improves there, do you envision any incremental M&A? Are there areas of the portfolio that you would like to complement or strengthen that you recently did do some M&A and introduce a new product as well through that?

We did. And what we've talked about is that the bar right now in aren't high for a lot of appropriate reasons. And so it has to be very line of sight for us and fit the building out of our consumer packaging business. And as such, it's going to have to be more about capabilities. something that we're not as adept at today that having it would fit us well. So we're getting into a lot of new categories, like trays, bowls, other things that have growth potential. And so our lens actually is a little wider than it used to be on what's possible, but the return expectations have to be as meaningful for us. And so the lens is probably a little wider, the bar very high, and it would have to be more focused on -- or the capabilities there that we can go the route of acquiring somebody who is disrupting, doing a good job creating something new, maybe early stage even or versus doing it on our own. And we'll make those balanced trade-offs as we build -- continue to build out the business.

Right, right, certainly. And you did touch briefly on decarbonization -- so can you give us just an overview of what your decarbonization goals are and how they fit into your spending plan?

Yes, it's an important question because as I mentioned in some of the opening remarks, we're a unique company in that we can actually invest in the circular economy, and that's unique. And so we established our science-based targets in 2023 through the initiative, Scope 1, Scope 2, down 50%; Scope 3 down 30%. And as we shared at our Investor Day, we've got a line of sight to it on Scope 1, Scope 2. We know the investments that we can and will make to achieve the vast majority of those Scope 1 and Scope 2 reduction goals and there will be some capital investments within the 5%, not above it, that we'll make, and we'll be able to get there. And so larger-scale investments inside of that decade of work recovery boilers that dramatically increase and decrease our fossil fuel consumption at our wood fiber facilities, as an example, warehouses that run very high productivity, very limited people intensity reduces the impact on that. And so we've got a great road map that is unique for us, and it's highly beneficial to our customers. We play a very real role in our customers' Scope 3 expectations. And so that's a big deal because they're looking for things to point to that they can put their arms around and a 50% reduction for us in greenhouse gases over the next decade, and there is benefit to our customers. And we'll go down the path to of acquiring more renewable energy. When it comes to the electrical side of the business. We've got line of sight to some of those how that's going to play out as well, particularly in Europe, where we don't have as much of a build, the lever to pull, like we do with our wood fiber mills here in the United States. So I think we're a bit unique in that we actually have the path. We can point to the projects. They're known. They're in our Vision 2030 expectations, and we plan to execute against them.

Well, thank you. Are there any other audience questions? Okay. Well, we're winding down time here. So we're going to finish with a quick lightning round -- now these are where I give you a question and you just say the first thing that comes to mind.

This ought to be good.

So at your Investor Day, you did change the way that you talk about the business or certain words that are no longer in [indiscernible] -- randomly, what's one word that rhymes with this integration?

Information because I wasn't going to say [indiscernible].

You didn't say the word.

I didn't do it, but I would say, just to play that out for you. Our team did a phenomenal job of bringing together our Investor Day. And we are at the New York Stock Exchange. They do a great job of capturing it. And so if you haven't had a chance, I'm not sending out to our website, but everything we've got talked about today is out there. It's in 20-minute snippets. Just to kind of pick up on, if you want, Michelle, Fitzpatrick, who did a great job of talking about or the ESG goals and the like, it's out there. And so take advantage of it. It's good. It's well done. And so yes, that's information, fine.

It didn't take a [ day ]. And lastly, 2024 price cost equals.

Yes.

Okay. Yes.

There will be a price cost.

Fair enough. Okay. Well, with that, will grab our [ baggages ]. Thank you, everybody. Steve.

Thank you.