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

Good afternoon, everyone. Gabe Hajde here, Wells Fargo paper and packaging analyst. Joined by my colleague, [indiscernible], welcoming Graphic Packaging. Thank you, both gentlemen. We have representation CFO, Steve Scherger and new to GPK but not to the industry, Mark Connelly, probably heard that a bunch of times, Senior Vice President, Investor Relations and Strategy Development. So we welcome you all. This is intended to be sort of a fireside chat. If there's any questions or things that pop in your mind, please don't hesitate to ask.

I think, Steve, we talked about maybe a couple of minutes, maybe a few slides overview of the company for those who may not be familiar. And then maybe what differentiates GPK or Graphic Packaging, why customers choose you over your competition?

Yes, I'm glad to do that. And thanks, everybody, for taking a couple of minutes to join us here. And Gabe, thanks for taking the time and no slides. But let me just talk a little bit about who we are as Graphic Packaging. Graphic Packaging, we are in your life every day as a consumer packaging company. We are entirely committed to the consumer. We're in the day-to-day life of how we all spend our time when we're eating, drinking, whether it's at home or on the go or managing our lives at home. And so our business, roughly a $9 billion business today, is literally functioning in all of our lives on a very nondiscretionary basis on how we spend our time, whether we're eating and drinking at home or we're heading through a drive-thru or we're feeding our pets or taking care of ourselves at home. And that's really a business that we've built by design over the last 5 to 7 years, evolving into a business that chooses to make raw materials or paperboard where we see that there's an opportunity to develop and make packaging. Today, 95% of our sales are making a package that you and we, as consumers interact with, which is really important because it allows us to have exceptional line of sight into the day-to-day lives of the consumer. And also our business, as we built it over the last several years, really moves with the consumer. And so whether you're a consumer who prefers branded products, we're there to support you. If you're a consumer that has a bias towards more private label products, we're there to support you and our customers in that case. Obviously, whether you're here in North America or throughout Europe that's where the majority of our presence is. But whether your day-to-day consumption patterns are at home or you're driving through a drive-thru, we're there, whether you're doing most of your shopping at a big club store or at a bodega around the corner, we're there. And so we tend to move with the consumer very, very well. We've built the business with margin stability and growth in mind. And today, with the capital investments that we've made 15 acquisitions over the last decade, small, medium and large, some very large capital allocations to create competitive advantage in what we do. We've really created the essence of and the reality of a consumer packaging company.

Appreciate that introduction. There's been a lot that's transpired over the last 4 years, not to digress, but one of the things that we learned, I think versus observing prior cycles is the impact of inflation on the consumer. And so we had -- not something we had to deal with, really, I don't think to the extent we did for a long time. So post-COVID burn off, and now we're in this -- what feels like the most stable we've been, inflation, how does that impact the consumer from a consumption standpoint and then maybe Graphic Packaging?

Well, you're absolutely right that we've seen a bit of unprecedented inflation, obviously, for us as consumers. And obviously, that flows through the realities of the production of packages and packaging and the products that all of us consume every day. So it's been an incredible focus of ours over the last couple of years, particularly to make sure that we have a deep understanding of what's happening to our cost structure and to work with our customers to make sure that we're paid appropriately for the value that we provide as I mentioned a moment ago, we're a packaging company. And so our customers buy packages from us that have value. And so we've had to really ensure that we're being compensated appropriately for that value, but that the products themselves have better circularity, more functionality, more convenience so that our customers and you as consumers actually prefer them because really, at the end of the day, we have to have products that are preferred by our customers as made from renewable resources, recyclable as well as by the consumer. And so yes, there's been some inflation that's moved through the business, and we've been able to really ensure that we maintain our outstanding relationships with our customers, and have very sticky and long-standing relationships with them that they see the value in what we do. In a lot of ways too, we've become an important part of their innovation engines because our customers are making very substantial commitments to greenhouse gas reduction, science-based targets, lower impact on the planet. And we're one of the unique packaging companies given our commitment to a circular economy greenhouse gas reductions where partnering with us to create products that are preferred by consumers but also allow them to help them meet their long-term goals, has been really important. So a little bit of a longer answer because it has complexities around the important value that we play with our customers. But it's been an unusual environment where the consumer is now, of course, under appropriate pressure. And thankfully, we're in our day-to-day lives pretty nondiscretionary. But because we kind of moved with the consumer, we have seen movement from branded materials to private label or we have seen some movement of more at-home consumption here more recently as the consumers come under a little more pressure. So those are all things that are really important to how we day-to-day really navigate through the company.

The at-home comment that you're making there, is there any reference that you guys obviously have been 22% or so exposure to foodservice. Are you seeing that in -- are you based on foot traffic? Or is it based on sort of what you're seeing internally in order patterns, et cetera?

It's more seeing what you read, what others read is that the consumer, as they have come under some pressure are navigating some of their dollars that they're spending on food and beverage consumption movement with the QSRs, they're all expressing a little bit of some volume challenges and really what that resides for us is movement to the home, which is just fine for us and is actually just perfectly fine as the consumer is kind of moving from one place to the next. As you know, our foodservice platform is a phenomenal long-term growth platform for us. We're excited about it. The number of conversions that are happening from foam cups, as an example, or other alternatives into our fiber-based solutions, it has a long-term growth trajectory, and we've seen growth in that segment for the last couple of years as we have more and more products replacing other alternatives into our solutions.

About 2 years ago, you entered into the European market in a bigger way with AR Packaging. One of the concepts that we're hearing about now is you've got a couple of transatlantic potential corrugated packaging mergers is that the way the consumer interfaces with the -- with their products, the fast-moving consumer goods in Europe is a little bit different than what we are accustomed here in the United States. They talk about being a solutions provider on the corrugated side and how they merchandise on the shelf versus here in the U.S. Do you see that in your AR Packaging business and does it -- do you view it as an opportunity or as a risk as you look forward?

I think we view Europe, broadly speaking, as a very real opportunity for us. As you said, a couple of years ago, the AR Packaging acquisition was a significant facilitator for us of creating scale throughout Europe and acquiring a highly innovative company, and we actually couldn't be more pleased with the innovation platforms that came along with that acquisition that we are now executing on throughout Europe and that have very long runways for growth in North America as well. And so Europe and the European consumer really continues to lead the way when it comes to a commitment to renewable products made from renewable resources that can be recycled that can be generated multiple times for them. They feel good about the products that we produce on their behalf. And the regulatory environment there is well beyond that, which we're seeing in North America. And for us, it's in a positive way because the regulatory environment is moving in the direction of fiber-based packaging solutions. And so for us, we really see it as opportunistic, not only for our European platform, which we expect to continue to grow within the context of the total company, but also we're watching very real products that are coming to life, innovative, fiber-based in Europe making their way to North America. And while the pace of that tends to follow Europe, a great example is our Boardio solution, which is replacing a lot of rigid containers, rigid plastic containers, takes about 50% of the plastic out of a package originally for baby food. It moved into like candy, like your mentos package that's moving into a fiber-based solution and now moving into coffee here in North America. It's a great example of started in Europe early adoption and then migrates its way to North America. And our portfolio of $15 billion of addressable market opportunities is made up of many innovations that have started in Europe and make their way around the world, particularly make their way to North America.

So you mentioned the $15 billion. I had it in the list here, so I'll move it up a little bit. There's a couple of different categories in there. There's trays and cups and like you have some canisters in there. Is there an impediment or maybe an investment that your customers have to make from a filling standpoint? Because I think sometimes when we think about format changes, that could be challenging for test the CPG to make an investment to transition over, again, some of which maybe is legislated in place. But just understanding that dynamic and maybe that's what makes it such a longer-term play is that it takes time.

Yes. And it's a great question, by the way. And the answer is it goes across the entire spectrum, sometimes yes, in terms of it takes time, sometimes no, it's plug and play. And so we'll often times start with the pursuit of something that is more plug-and-play, meaning that our customer needs to make a more limited investment to transition from one package style to a next. An example of that might be that a plastic tray that runs across the trade line that our tray would actually be capable of running across that line and have a different sealing capability on it. So those types of transitions can happen very quickly. The transition, for example, to our new Rainier coated recycled paperboard product, which is the world's lowest cost, highest quality coated recycled paperboard that can now compete effectively to do packaging for health care, for pharmaceutical for high-end beauty care products that historically have been required to have an alternative paperboard SBS or bleached paperboard. We can now service that. Well, that's a plug and play. That's just moving to our solution from existing. Others take time, beverage packaging solutions where you're changing out that 6-pack of plastic rings to one of our fiber-based solutions that's a real investment that's made on behalf of and with our customers. Those take time to get to the point of conversion and then you've got a multiyear window where an entire platform whether it's with a nonalcoholic beverage customer or a beer customer, where they'll then make investments to transition their entire portfolio into those solutions. So it runs the gamut short to long. But what's positive about that for us is we've always got great line of sight to that new product development platform, what's in motion, what stages are we in and where are we in the successful migration into those new packages.

Understood. Diving in a little bit to maybe more near-term trends, not just for you, but for the packaging industry in general, growth has been -- organic growth, at least has been a little bit elusive. Any updates in terms of the first half, how things are unfolding relative to maybe initial expectations coming into the year and then maybe the setup into the back half of the year. There's -- I could see we have some Nielsen data out today on the beverage side, things didn't seem to maybe shape up the way initially thought. Just any thoughts, comments there?

Yes. No, more than glad to. I think the first half for us volumetrically is shaping up as we expected coming out of Q1. What we saw in April was snap back just given how the days fell around the Easter holiday. So April was positive. May was sequentially better than April. So our second quarter looks to be on track for what we characterize volume wise kind of being flattish to up modestly. And then our visibility into the second half being up 3% to 4% remains on track mostly driven by 2 things. One is the innovation engine we're talking about this year will generate about 200 basis points of new-to-the-market, net positive organic sales growth that will happen throughout the year, but the second half of the year, a good line of sight to that. And then we will have -- last year as we managed through a little bit of retailer and CPG destocking, most of that -- all of it is really behind us. And so we expect to see some positive organic sales growth in the back half of the year. There's no doubt that the consumer on a day-to-day perspective is appropriately stretched, which is why, actually, as we look out to our own views of the second half of the year, we aren't assuming that the consumer behavior patterns change to the positive. It's kind of stable. We're not really even assuming yet any material movements forward on promotions and the like just because visibility to that kind of happens when it happens. But no, our confidence in the first half remains as we articulated coming out of Q1, the same for the full year.

On the volume side.

On the volume side.

Yes. Competitive landscape we've read mixed reports about imported board making its way into the U.S. And then even to the extent maybe some European suppliers are willing to manage inventory state side to alleviate some of the extended supply chain concerns. We got Red Sea disruptions, shipping disruptions. What are you all seeing, again we read the trade publications, but we're not making folding cartons on a daily basis.

Yes. I mean I think if you stand back from the company that we have today, as I mentioned earlier, I mean, 95% of everything we do is making an actual package. And it's really important because our relationships are with the CPGs, they're with the QSRs, that's who we sell our packages to. And our relationships with them are deep. They're long-standing, we've got to reearn those relationships every few years because most of them are, in fact, contractual. And so yes, there's all kinds of the dynamics of paperboard moving around the planet, but our ability because of our incredibly low-cost and high-quality infrastructure, manufacturing infrastructure and our ability to create new-to-the-market products results in very, very long-standing and great relationships with our customers. Yes, on the edges, there's some paperboard moving around that may come in from other parts of the world, Scandinavian countries specifically. But on a relative basis, we don't actually see those having an impact on our relationships with our customers and the innovation momentum that we have with them. And as you know, on the opposite side, the export side, we actually aren't an exporter of paperboard to anywhere around the world. We only send a paperboard to ourselves to turn it into a package. And so that's just not a part of the market that we participate in. And so no -- and the great thing about as we've worked with our customers over the long term, packages tend to be -- they're just fit for purpose. They're fit for purpose relative to the functionality, relative to the types of raw material or paperboard that are in them, relative to their role in the circular economy and there's -- we've got a long history with them on making sure that their packages are fit for that purpose utilizing our capabilities.

I would just add to that, that in our business, there's no such thing as a spot market. If you're selling paperboard, there's a spot market. You can dump paper here and there. But our customers, we're selling packages that have to be specified. They have to be proven out. You've got to be able to execute in all of the places they need to be. So there is no sort of short-term moving around. Big CPGs don't say, "Hey, I can get this product a little bit cheaper. And all I've got to do is absorb some freight risks and foreign currency risk and a whole bunch of other risk and buy it from a high-cost region. But leave all that aside, there just isn't that kind of short-term trade. There are pieces of the market, and you'll find a spot piece of business like that, but it's not in our book of business.

Okay. There were some price initiatives out there earlier in the year that didn't find success thus far. We've seen other grades out there with a second hike. I think we published this, this is consistent with our research that seemingly on the containerboard side, some of it is cost push. To the extent that your price increases were not successful or maybe they were and just again, there's a separate topic about price discovery and the whole paper market in general. But just how that played out. And if it sort of dies on the volume [ until you're ] saying we have to go out with a fresh price increase, if it's warranted.

Yes, I certainly don't want to comment on any future pricing initiatives. But relative to those that we have in motion where we can execute on them outside of the third-party index we are where we're in renegotiations, standard typical renegotiations with our customers. We're taking appropriate price actions. And I think it's important to just take a moment kind of to that point around the price change mechanism. As we've talked earlier, we value and value price our customers and have for years based upon the value of the package. And so that package has a value. And what we're really talking about is how the prices move within our contractual relationship with our customers. And so we'll -- we obviously, and you know us extremely well, we've got exceptional line of sight to what's happening with our costs. We also have very good insights into what's happening in the supply and demand environment and our specific demand environment, and we'll take appropriate price actions consistent with that.

Yes. One specific cost. I mean, I know recycled fiber OCC seems to be fairly well telegraphed. Is there anything else behind the scenes with sorted office paper that you may use as an input or furnished to the mills that's up because as a derivative of pulp.

Nothing that I'll point to specifically. I think one of the things that is unique about us though is that, particularly with Kalamazoo and what will be true with Waco, and those are our 2 coated recycled paperboard manufacturing facilities, is because we have the world's best cleaning capability, so the ability to take recycled fibers and turn them into a package or into paperboard and into a package. We actually have the ability to take a wider variety of inputs than most. And so while many businesses, the competitors may need to have a higher proportion of higher cost recycled fibers, our ability to take a more cross-section of recycled fibers into our mix, if you will, is actually better than most, which actually keeps some of the cost pressures that you're talking without a little more minimized, but nothing that I would point to specifically there. And then to your point on the realities of commodity costs, yes, there are certain things that are inflating and there are others that aren't. And so overall, that basket of cost for us are reasonably low inflationary currently. But as we talked a moment ago, pockets of it where we see inflation is something that we're extremely mindful of.

Shifting gears. You mentioned Waco, I don't think anyone would deny Kalamazoo was a success. You guys got a little bit more productivity out of it. Maybe the price tag was a little bit more. But Waco last update was maybe a little bit ahead of schedule. You pulled forward maybe a little bit of spend. Any updates on Waco?

Overall, in Waco, which is the second low-cost, high-quality coated recycled paperboard facility that we'll be bringing to life in the Texas triangle in Waco is going to be the second very good investment that we'll be making to really change the overall cost structure and capability of coated recycled paperboard, particularly relative to that which we produce. And Kalamazoo has exceeded expectations relative to one thing particularly, and that's the quality of the paperboard that we're producing. And so our confidence that coated recycled paperboard that we'll produce in Waco and in Kalamazoo, which will be the 2 facilities that we'll have once we bring Waco to life and close our other facilities. Our coated recycled paperboard facilities is just fundamentally going to make higher quality product than is available anywhere else. And that allows us to have confidence that the paperboard manufacturing infrastructure that we have will be capable of supporting our packaging growth for years to come because we'll be able, for example, to utilize coated recycled paperboard out of Waco or Kalamazoo in places where it would have required a coated bleached paperboard like SBS in the past, we can now utilize to make whether that's health care package, pharmaceutical package, think about toothpaste box. We'll be able to service that out of our facilities, which really allows us to support that couple of hundred basis points of growth as an enterprise as a packaging company for years to come, which really is a compelling part of why we're excited about and to have confidence in the return profile, spend $1 billion, get $160 million of EBITDA over the couple of years post bringing that to life -- starting to bring it to life at the end of 2025.

Got it. There were some competitors that entered the North American market, one of which has been here for a while, pretty close to commercializing a conversion project in the Northeast, one that has you all kind of appropriately pointed out, could change the scope and timeline, which they did. What do you think changed in the marketplace from their perspective that caused that change in Michigan? And then any early indications from what you're hearing about the conversion project and how they're looking to enter the market?

I think overall, over time -- supply/demand return expectations over time rule the day. And I think that whether it's any project, the specific one you're referencing in the Upper Peninsula of Michigan, we had a point of view from the beginning that, that was going to be difficult to do and generate appropriate returns. And I think that leadership made the appropriate decision that, that was an investment you could get a return on. And the conversion project you're referencing up in Maine, they've participated in that market has an open market producer of paperboard for a while. And I think what's critical is that's a play that, that particular competitor is choosing. Other competitors are choosing to be in the business of making paperboard, either bleach paperboard or in the form of Europe, FBB paperboard. And I think you'll notice that we've literally chosen not to be in that market with the sale of our Augusta facility because that's really where we felt that it would be very difficult to create competitive advantage. And so we've made a decision to not be in that side of the business where we didn't think that we could create competitive advantage making paperboard. We'll focus our competitive advantage on making package that utilizes paperboard from competitively advantaged facilities in places where we make coated recycled paperboard, unbleached paperboard and cup stock. And so it's a very specific and dedicated decision that we've made. It's a capital allocation decision about investing where you can actually create advantage and where the consumer is going to also be equally as advantaged buying products from us through our customers.

Got it. We've had some fairly healthy dialogue debate with investors around the value-add and packaging in general, specifically on the fiber base side, if you kind of run the mills to move tons or if you're focused on the local oligopolies and the folding cartons in your case, and again, there's different financial metrics and reasons why you do one over the other or choose to do both, choose to be just an independent converter. From your vantage point, building the business that you have today, do you see merit in only being a converter, again, pretty similar to what you're doing over in Europe and why?

I think what we see is that we'll make decisions as to what assets we will have to drive our business dependent upon our ability to create above cost of capital returns and grow and generate significant cash flows to put back into the business. So in North America, having the world-class paperboard manufacturing facilities that we have to support our packaging makes all the sense in the world because the return profile is excellent. We can generate above cost of capital returns for our investors, and it can grow and you've seen us put capital to work in that way. In Europe, to date, we've elected to just be focused on the packaging and have indicated there isn't a need for us to invest behind the paperboard because it isn't clear to us that there's an opportunity for competitive advantage or ROIC that would differentiate the business. So I think you can have different strategies in different regions, but they're still driven by what's your return expectations? What are your ROIC expectations? What are your growth expectations? And that's really what drives our decision-making as opposed to a one size fits all. It has to be this way in this region or this way in that region. And as you know, consolidation has been much more material in North America, much less so in Europe. There's still much to do, I think, consolidation-wise, in Europe over the long haul on the packaging front specifically. But I think that right now how we've positioned ourselves in the 2 regions is really about return expectations, growth expectations and the cash flow we can generate, and they don't have to necessarily be common.

Okay. Vision 2030, you guys laid out, say, February this year at your Investor Day. Just maybe quickly, there's a shareholder return algorithm in there that talks about low single-digit growth translating into mid-single-digit EBITDA growth. You also had kind of at the same time elected to change a little bit of the way you talk about the business in terms of top line growth and targeting on margin. Maybe one feeds the other. But how was the development of Vision 2030 different from 2025, excuse me, and what are the milestones that we should be looking for?

Yes, it's a great question. And Vision 2025 in many ways was our build to company vision. In other words, go from the $4 billion company that we were with a limited set of market participation, limited number of customers to the $9-plus billion enterprise that we were able to build and a little faster than Vision 2025, they built it by 2023, but it really was a build capability vision, which we were fortunate to make several decisions that prove to be good returning decisions, the Kalamazoo decision, the multiple acquisitions, the building our innovation engine, the AR Packaging acquisition. They were returning investments that actually created the opportunity in early 2024 to say, okay, now with that business, let's put a Vision 2030 out that actually has a return algorithm to it that gives us confidence and you the investor confidence that we can grow the top line consistently organically low single digits through organic growth coupled with, of course, appropriate pricing for our products, have that result in mid-single-digit EBITDA growth and then obviously in order to EPS growth. And we felt like the algorithm was the way to go to show that this is a business that has made the move into a consumer packaging business that can have and will have margin stability that allows us to grow the business in that way consistently. It will be lumpy at times, of course, but to over time, grow it in that way and move beyond the realities of [indiscernible] cyclicality, here we go again and say, "No, this is actually a business that sits in the hearts and the minds of the consumer is a harbinger for what's happening in the day-to-day life of the consumer and actually has a return profile, a margin profile that is steady and consistent that looks like a consumer packaging company and is a great harbinger for what's happening with the consumer.

Understood. Maybe one last one. We're sitting here 3 to 5 years from today. In your mind, maybe that one key factor on the upside or the downside or one risk that could derail Vision '23 from being a success and/or one thing that, that could help?

Yes. Listen, we're talking about it all the time. And certainly, as we look to the future, the key is what we just chatted about is going to be the volume and the top line. Can we grow this business when we grow it organically, consistently and have that result in steady and growing margins, incredible cash flow generation that's a business that will be and can be very successful on a go-forward basis. And it will be exactly what you just said is as we built the model around kind of low, mid, high, and when we do that, it will be incredibly successful business. Does it have upside from there? Yes. If we actually see the innovation engine and more conversions to be even more favorable, yes, the downside not as successful on the business growing consistently through innovation, through organic growth. And so I think it will be a window around those things. I think our view is that window around those will be pretty small because of the things that we can control inside of that.

Anything you feel like is misunderstood about the story?

It's all that we were just chatting about. I mean we've made a significant investment in becoming a consumer packaging company. And I think us continuing to show that this is a business with incredible capabilities around margin stability and margin growth over time, have allocated capital, and we'll continue to allocate capital thoughtfully I think that is actually where the upside potential exists and how the enterprise is valued.

Understood. Thank you.

Absolutely.

And we're up on the time.

Thank you, Gabe. I appreciate it. Thanks for taking the time.

Thank you, Steve. Thank you, Mark.