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

Thank you, Phil, and good morning, everybody. It's nice to be here. I appreciate the invitation to come to the industrial conference. And first we're first up on presenting this morning on the packaging side, which is great. We appreciate that and your interest in Graphic Packaging. I'm going to start by basically through the safe harbor statements, making the case for why Graphic. And that's really what I want to do over the next 20, 25 minutes in my prepared comments. Then we'll open it up for questions from the floor. Hopefully, there are some there. Phil's got some, too. So I'm sure we'll use our 35 minutes in a productive way. Look, I mean, if you think about Graphic, one of the things we've really done over the last 7 years is transformed this company. I'll go into some details in terms of what that really looks like. The last of the major expenditure getting ready to wind down with our Waco investment in recycled paperboard manufacturing facility in Texas. And we will inflect to serious cash flow generation, really driven primarily by the reduction of CapEx going down to a more moderated level at about 5% of sales, as well as the EBITDA that will come from Waco, as well as some working capital reductions given. We just really shrunk our paperboard manufacturing platforms make us more efficient. So that really will all inure to significant value creation for shareholders and something that I want to make sure that we outline for you. We do have some near-term headwinds that we're dealing with. Some of those have been pretty well chronicled. I'm going to spend some time talking about those when I get to a slide. We believe they're temporary, and we've got a lot of confidence in our long-term algorithm and the business model that we built. So let's jump right in. Here's Graphic at a glance. You can see we're a little almost $9 billion in sales. We operate principally in 2 markets, North America and Europe. We do have a little bit of sales outside of those regions which is primarily all beverage, servicing our large beverage customers. About 70% of it is in North America, 30% of it is in Europe. Europe is a growth market for us. We earn our cost of capital in Europe. We have good ROIC in Europe, even though we're not an integrated business in Europe. We do ship some of our own paperboard over there. I think the other note that I'd make here is the portfolio we have is really not commodity-based. We've got over 3,000 patents and a lot of intellectual property that we use for the packaging we supply our customers. We spent the last 7 years really transforming the business as part of our Vision 2025. For those of you who are familiar with us, and there are really 3 main things that we tried to do when we did that. The first thing we wanted to do is have more capabilities. For example, we didn't even have a foodservice business in 2017. And really, what that caused is if the consumer was eating out, we weren't getting those sales. So it impacted our ability. I'll show you a slide here in a little bit later on in the deck, all kind of profile that in a lot more detail for you and why it's important. But the big thing we did to address that is in 2019. We purchased International Paper's Consumer Packaging business, making us the #1 player in paper cups, roughly 30% of all the paper cups in North America we manufacture. We make the paperboard for that, as well as have 5 low-cost cup converting facilities there. We've also invested in innovation in a big way. Many people thought our expansion with AR packaging in Europe was simply just to get more geography. There was an element of that. It allowed us to get into Eastern Europe, which are great markets for us. But the biggest part of it was they were the most innovative company in the space, and combined with ours, that we had, we now have 5 global innovation design centers that routinely develop new and different solutions to replace primarily plastic and foam packages, and that's allowed us to really expand our markets, and I'll talk a little bit about that more in a minute. And lastly, we invested for competitive advantage. We had some bespoke opportunities on the coated recycled paperboard area here to take a significant step forward in terms of cost leadership. Our first investment was in Kalamazoo, Michigan, and one is pretty well chronicled and has gone extremely well. And then after that, we announced that we were going to do a greenfield facility in Waco, Texas which we'll bring online here in Q4 of this year. And as I mentioned earlier, at that point in time, we will have all our major investments made in this kind of long-cycle CapEx that we've been doing, high CapEx upwards of 12% of sales here will revert back to a more balanced level around 5% of sales or below. So we're excited about that. Look, this is where we were in 2017. I mentioned this earlier before we got our food service platform. We were largely dry foods and beverage, we kind of center of the store primarily. Our top 25 accounts represented almost 80% of our sales. It was nice from an SG&A standpoint. But again, if one of those customers got a cold, we got the flu. And so we really needed to build out our portfolio, and that's exactly what we've done. When you look at that same picture of the store now, we actually put a drive-through in there because we're getting the drive-through window as well. And a lot of the work that we've done around plastic replacement really allows us to get that perimeter to the store, and we'll be profiling some of those packages in our upcoming earnings report. We have here with Q3 with some things that we've done in Europe that are continuing to accelerate that. So really excited about that. Again, real balanced customer portfolio, which allows us to drive consistency across our revenue base. I guarantee you that in the last 24 hours, you've touched something that we make. Here are some examples of what we do. You can see there on the slide, the balance that we have really across our portfolio between food, beverage, food service, household and health and beauty. Health and Beauty is the smallest business. It came from AR packaging, and that really allowed us to get into that space, primarily in Europe. We're learning a lot about what it takes to be a successful provider of those cartons. We really provide a limited amount of that in North America, but we see that as an opportunity for us. Here's that slide that really shows that. You can see AR packaging's addition with the lighter green balls there. We really have a nice platform in Europe with 38 facilities now geographically located in the right spots to take care of customers. As I mentioned earlier, this is a nonintegrated business. We do ship about 250,000 tons of our own paperboard to ourselves into that market, and we buy the rest of the paperboard, which is a great position to be in given the supply and demand dynamics of paperboard in Europe. So excellent business, great innovation and AR packaging has really been a home run for us. Here's our 5 platforms that we drive as part of our innovation. And they're primarily -- $13 billion of that $15 billion is really focused on plastic and foam replacement. And what this has allowed us to do is really outperform our customers in the markets that we participate in. Look, we're not immune to our customers having volume challenges. And I'll talk a little bit more about what doing about that here in a minute. But what innovation has allowed us to do consistently quarter after quarter is outperform. And it's really a function of the innovation efforts that we have, and that's why we spent so much time investing in space. Here are some examples of some of the innovations we've done. You can see these are types of products that are available every day in the marketplace. Things and other consumers use routinely. And this will continue to be a key focus for us as we go forward here. Here's our Vision 2030. We put this together and we rolled this out in February of last year. And you can see there are really 4 pillars of this, starts with innovation. I commented a lot on innovation already and why that's so important to us, allowing us to outperform in markets that are a bit challenged, with innovation really kind of driving that uptick that we have. We focus on culture. We focus on people. At the end of the day, we have 23,000 associates that come to work every day, and they're driving our business forward, taking care of customers. We need them motivated, we need them to be committed. And so we work hard to create a culture that really fosters that kind of engagement and innovation across our entire company. We focus on making the plan in a better place. We do invest heavily to reduce the amount of carbon that we generate. I've got a slide in here, I'll show you how we're going to do even more of that. The investments on recycled packaging, I think, speak for themselves. We spent almost $2 billion in the last 5 years to create North America's lowest cost, highest quality recycling platform. We can now take dirty your fiber, clean it all up and put it into high quality packaging, and we've got a significant cost advantage in being able to do that. And most importantly, that's where the end-use customers really want us to go. They really appreciate coated recycled paperboard, where it can be used in a package, they want it used in a package. And all of that really inures itself and to do a good job on those 3 things, the results for both our customers, our shareholders and our employees as well. As I mentioned earlier, what I'm excited about with our Vision 2030 is once Waco is complete, we have everything that we need to drive this Vision 2030 commitments that we've made on this. It's not like we've got another big acquisition or another big capital investment that we need to make to go out there and do it. This is going to be about innovation and execution on the asset base that we have. I like this slide. It kind of organizes a little bit some of the things we're doing around sustainability commitments. I get asked all the time, are you still committed to reducing the amount of carbon that you generate? And the answer is yes. We're going to be thoughtful on how we do it. But you have to remember, almost half of our customers are domiciled in Europe, and they've specifically called us and said, look, are you still committed to driving the reduction of carbon and out of your company? And the answer is yes, we will be able to do that, and you see here on the lower section there that we expect to generate almost a 50% reduction in our overall carbon by 2032, with investments that we'll make in the business, all part of our 5% of sales on the CapEx line. So it's all in the numbers. It's not like there'll be some big capital call that we have to do. We've laid that out. If you haven't had a chance to take a look at our impact report, it's very detailed in there what we plan to do, how we plan to do it and the time lines that we've put together to do it, and that's really resonating well with our customers who have made some pretty significant pledges, even though some of those have been moved back a little bit. We need to be there to be able to support them, and we will be there. Investing in people. I've mentioned why that's important. All of you understand that. We need to make sure that we've got the right workforce and trained the right way to be able to do what our customers need them to do. And of course, the packages that we generate each and every day need to be more circular, more functional and more convenient. Otherwise, they just don't resonate with our customers. Those are the things that we have to do. So every time we have a new innovation, we've hit the mark on those 3 things, and that's really a differentiating point for us in the marketplace in terms of what we do with innovation. Here's our arrow slide that really shows our end-use markets. I think this really speaks to the diversification I mentioned earlier with some of the things that we did in Vision 2025, relative to building out our portfolio in that kind of the overall picture I showed you of the supermarket with the drive-thru in there. Look, you can see in quarter 2, we actually went sideways on a number of those. Health and Beauty was up a little bit. I think that's a pretty good testament. We -- if you think about what has happened here on the Foodservice side of the business has been pretty well chronicled some of the challenges that the QSRs have experienced. And yet the last 2 years, our business has been up pretty substantially. And the reason for that is we've been replacing plastic and foam in terms of cups. And so again, kind of giving you some real examples of how that works. Being able to shift and move with the consumer is essential. And that's what allows us to drive that consistency and the innovation allows us to drive market expansion, and really make sure that we outperform in terms of volumes in terms of what our customers are buying from us each and every year. One thing I will add, and I was asked the question in the hallway, and I want to make sure that I addressed this too in terms of Q3 volumes. Those of you who follow consumer packagers, or consumer goods companies, I should say, food companies and beverage companies. Several of them have released in the last couple of weeks, some of our customers have. So you're probably not surprised to know that our Q3 is off to a little bit of a mediocre start. We had kind of forecasted to be plus or minus flat. And we're probably down about 2% through volumetrically, through the middle of August, really a little outperforming relative to what we've seen in terms of Nielsen and some of the other data but I am willing to share that with you today. We spend a little bit of time on this slide. This is an important slide because it's really part of the case that I need to make around why Graphic. If you look at the far left-hand side of that and take a look at the volumes, you can really see what we've been dealing with for the last couple of years. If you look at 2023, as our customers kind of rolled out of COVID, they dealt with the destocking, got their inventories back in line with where they wanted them to be. I get asked a lot is there still destocking going on? If there is, we don't really feel it as a material impact, I think most of that is in our rearview mirror. But you can certainly see where it was in 2023. Our volumes held up pretty well. We did take a fair amount of market-related downtime in our paperboard manufacturing facilities to make sure that we dealt with that, matching our supply and demand like we always do. But you can see the margins held up pretty good during that period of time. There are really 3 things that are impacting us right now. We view them as unusual, and we view them as temporary, but they're real for us in the near term. And so I need to talk about them and make sure you understand how we're viewing them, and what we're doing about them. The first one is really the fact that food is extensive. If you take a look at really what's this has been, again, well chronicled, our customers raised prices pretty dramatically during the COVID era. And they've been reticent for all the right reasons not to reduce those costs or reduce the pricing. In many cases, their costs are up pretty substantially as well. But affordability remains a challenge. The consumer is stretched. And so that's impacting our customers' ability to drive their volumes. I have to tell you, it's gone on a little longer than I anticipated it would. But there are some green shoots that seem to be happening. Of course, you read journal as I do this weekend, there was a fair amount of news in there around what's going on with the big CPGs, 4 of our big customers were mentioned in there. So from our standpoint, we believe it's being addressed by those companies and those Boards. And they've got a long history of reformulating and repositioning their business in order to resonate with customers. And I anticipate that they will. All that said, that takes some time. Reformulation doesn't happen overnight, repositioning some of these brands. It takes some time as they're going through some of their -- the changes that are going to happen in corporate structure and things like that, we'll have to deal with that over that period. But they will get it right. I'm quite confident. These are well-capitalized companies with great brands, and they've been through different events in the past and been able to do it. The second part of that is really dealing with what I'll call the MAHA movement and GLP-1 drugs. And they're different. I mean the MAHA movement is really somewhat expensive for our customers and comes in a very inopportune time for them. They're already dealing with some of their volumetric challenges. And now they're having to go to reformulations that almost always are more expensive, just kind of a fact in terms of what's happening there. Replacing some of the artificial flavors and colorings that are out there. And that takes away from money that they otherwise could be using for promotional activity, slotting fees and things like that. So it impacts some of their demand. They'll work through that. Most have made pledges to do it, '26, '25, '26, and I think some early '27, so it will kind of flow through there. But it is something that they're having to address, and it's a near-term headwind for them for sure. GLP-1 drugs, I could make a case is actually probably more of a friend for Graphic than a foe. We don't participate in kind of the salty snack category in a material way. That's mostly film, plastics that do that. And again, customers will reformulate some of whom already started doing this with higher protein type additives in food. And any time they reformulate or look at a different size, that's an opportunity for Graphic. But again, it's churn that our customers are dealing with. They're having to figure out how they put the resources on this and it takes some time for them to get it right, but I believe that they will. A third element that's impacting us right now is really kind of a truly interesting and unusual situation, and that's on the paperboard market, specifically SBS. So that's the white paper board. We're a small player in that market. Almost 80% of everything that Graphic does is on recycled paperboard or unbleached paperboard. The biggest thing we do on the bleach paperboard side is paper cups, and that's a really good market, as I already mentioned to you. But on the coated SBS market, there's been capacity added here in North America to a market that was already well supplied. It's driving operating rates down pretty dramatically. One analyst wrote this morning and he's right. There was a 520,000 ton machine added into a market that was operating rate of around 82%. So what that's doing is that's keeping a bit of a collar on our ability to push pricing on coated recycled paperboard and unbleached paperboard. And it's really kind of a new phenomenon because if you look at the spread on coated SBS and go back 10 years, it used to have a 40% premium over coated recycled paperboard. That premium right now is as markets is down to 7%. So it's a very, very unusual spot to be in, particularly when you think about it cost 50% more to make that paperboard than it does to make coated recycled paperboard and the CapEx requirements are substantially higher, almost 4x that of coated recycled paperboard annually. So our opinion is, is that really no producer that's making that right now it's probably earning the cost of capital. So it will get solved, but that's an issue in the near term that we're dealing with. So those 3 things are really what's impacting us. You see it in our adjusted EBITDA margin. Our confidence remains high in our business model and the investments that we've made. Again, we've more than doubled down on coated recycled paperboard, we're the lowest cost producer of that grade. But these issues do impact us, particularly the SBS in terms of what those markets are doing in the near term. So it's something that we have to watch. It's not ours to sell. We're a small player. We're actually busy on our coated bleach side of the business and our cup business. We have 2 machines in our Texarkana paperboard manufacturing facility, one makes cup, the other makes coated bleached and both of those are very busy because it's -- they're over 95% integrated in our own stuff. So it will be someone else that needs to do it. It won't be us. But in the near term, that's a headwind that we have to deal with. Here's our base capital allocation model as you look there in our algorithm. We're obviously behind a bit on our base model. We're not generating those results right now. But our confidence over time that we will is very high. You can see low single digits on the annual sales growth, which really assumes kind of, call it, a flat market than innovation really being what gets us into that low single digit. Right now, that innovation is getting us closer back to 0 so far year-to-date in 2025, with markets being down a couple of percent. So we're not hitting on that right now, but we believe we will over time for the reasons I just got on talking about what our customers are doing, reformulating. And that drives adjusted EBITDA growth of mid-single digits. It's pretty mechanical for us. We get good absorption relative to that level of growth. That drives high single-digit EPS growth. And I've already mentioned our CapEx is going to revert back to 5% of sales or less starting in 2026. So that's like 6 months away from now relative to what you can expect from us. And that drives our capital priorities, which are listed there to reinvest back in the business. We need about 2% of that 5% is what I'll call true maintenance CapEx. So even at 5%, we're investing into new markets into lower-cost assets things that make the company better. It's not like we're starving the company of CapEx. We have a well-invested company, very well-invested companies. As a matter of fact, and we will continue to be smart about how we allocate capital to do that from an investment standpoint. We want to grow the dividend. You've seen us made a couple of moves here about every 24 months, we take a look at that. We think a growing dividend attracts investors, investors that want to invest in a company like Graphic. So committed to that. We've been pretty upfront around our desire to reinvest, repurchase our own shares, if you will. We have allocation right now about $1.6 billion out there. And you saw us in our second quarter, I made some moves. We have to manage that in accordance with our leverage ratio, which we said we'll finish the year around 3.5x. But with our stock trading where it's at, it's pretty clear what's the best priority for us in 2026 is. You can expect us to continue to be very focused on that. Getting investment grade as part of Vision 2030, that's in the cards here too. We need to get our leverage down a bit, which we will. It's pretty mechanical with the cash flow generation we're going to generate over the next few years. We think that's important and that will be another leg of the stool in terms of our overall financial stability. And I have to tell you that M&A, do we look at it? Sure. But is the bar extremely high in this environment? Absolutely. And it's even higher now given where our stock is trading relative to what we can do with our own reinvestment back in our company in purchasing our own shares. So that's how we think about capital allocation as we roll into 2026. This slide basically just shows the cash flow, and we've adjusted it to kind of show the jump-off point a little bit lower than where we had anticipated to be. But I think the point you really need to take away from this is the vast majority of what's driving that uptick in the free cash flow is the reduction in CapEx. Then you've got a little bit of Waco coming on $80 million next year and $80 million the following year, a little bit of working capital. And then there is some growth in the overall business, but the big uplift here isn't around, hey, our volumes have to come back and be 3% in order to make this all happen. Certainly not in the near-term years that we've got. So our confidence in our ability to generate that free cash flow is very high. And you should take some comfort in the fact that we know how to repurchase the company back. The slides in there. We bought back almost 25% of the company since we did the acquisition of IP's consumer business in 2018. You can see it there. We've been pretty smart about how we do it, and we've retired those shares in a way that has been value creating for our shareholders. There's our guidance and commentary, which is unchanged. And with that, Phil, I've got about 10 minutes left. So I'm happy to take in questions.

I'll kick things off, and then we'll open up the degree. Mike, so I appreciate all the great color. The 3 headwinds you talked about, whether it's SBS, MAHA and just volume challenges as consumers seek value. Those don't seem to be an easy fix in the medium term. So in that backdrop, what are some of the levers that are at your disposal to kind of grow earnings? Or is it going to be a pretty muted EBITDA environment? And just cash and things that you can control? So just kind of help us think about the longer term, the medium-term algo.

In the near term with those is the headwinds that we're facing right now, our focus is clear. I mean we've got to get Waco up and running which will start up here in Q4 of this year. We're heads down really focused on that. You should have a fair amount of confidence that will be successful given it's an identical paper machine to the one we started up successfully in Kalamazoo in 2022. So we've got a lot of people there that know how to do that. We need to continue to drive innovation. We have to help our customers win in this crowded market space with the things that they're dealing with. And suppliers that help them win when they're going through all these changes and struggles are the ones that are going to be rewarded with additional volume. We have to earn that. Our cost structure is such that we can be smart about where we would decide to take strategic share. and really focus on the investments that we've made and leverage the investments that we've made to make sure that we hit the volumetric targets that we've put out there. So I think when you look at all that, those kind of operationally, what we're focused on. And then the capital allocation piece of it, Phil, as I mentioned, is another area we generate alpha for our shareholder base, and I've kind of alluded to what our priorities are. So near term, that's what we have to do.

Super. Questions in the audience?

Yes. Can you talk a little bit about -- can you just clarify a little bit about this reduction in cash flow long term that you guys talked about with your Q2 call and how we should think about that? What does that all mean?

Thank you for the question. And so really, as I mentioned, our jump-off point is a little lower as we go into next year. So that's why it was the $80 million that we talked about. And I think you're specifically asking around when do we get back to $1 billion, which is kind of what we guided with the Vision 2030 piece. The question is, I don't know for sure when those 3 things really kind of take care of themselves, but they will take care of themselves. Our customers will find their mojo. They will reformulate. And on the SBS side of the business, people aren't going to operate paperboard mills that aren't earning the cost of capital in infinite. Sooner or later, someone is going to make a decision. I've been doing in 35 years, it always happens. It seems like it takes longer than it should. And as I mentioned, this is one we're kind of on the sidelines watching and waiting, so it does impact us, but there's not a lot we can do in the short term there because our facility, as I mentioned, in Texarkana is running full. We get some collateral damage on that, and it certainly puts a cap on what we can do on our other 2 grids, which by the way, the backlogs on both coated recycled paperboard and unbleached paperboard are very solid, as you saw, and Phil actually wrote about in coming out of Q2 with the AF&PA data that was released. So those are again the things that we can do. And I think the thing that you can count on is that we're positioning Graphic to be spring loaded when that does get resolved, and it will, that we're in a good position to take advantage of it and kind of close that gap. But I can't give you an exact timing on it.

Just a technical one related to the same question. So 2026, you gave free cash flow guidance of $700 million to $800 million and then you said cash requirements from $750 million to $850 million -- just looking at 3 components CapEx, $450 going back to 5% of sales [indiscernible] and the tax [indiscernible] $230, that puts me at $900. What is this like have you built that coming from this or that the build or how do you look at the [indiscernible]

It's a combination of things. The big beautiful bill is a portion of it as well as working capital reductions on the downsizing, specifically inventory downsizing to 5 very well-capitalized paperboard manufacturing facilities.

Yes, there's an inventory optimization in there that we couldn't do before Waco. We need to build up our inventory to get ready for the closures. So inventories and then, of course, with customers coming in short, we ended up with inventories even higher than we expected. But the big beautiful bill has a significant positive for us with the bonus depreciation.

Our timing was quite good with Waco as a result of that legislation.

[indiscernible] And then the very to -- can you just on the format the expectations were flattish.

Yes. So through -- what I've said is through the middle of August right now, we're seeing -- we had guided to plus or minus flat and we're down 2% through the middle of August volumetrically.

Yes, the plus or minus flat is for the year. But third quarter tends to be a good quarter, and it's starting off well.

We had a number of customers that actually took the week of the fourth of July just down a manufacturing. And so that impacted us a little bit there. Other questions, Phil?