Graphic Packaging Holding Company (NYSE:GPK) Q3 2023 Earnings Call Transcript

Graphic Packaging Holding Company (NYSE:GPK) Q3 2023 Earnings Call Transcript October 31, 2023

Operator: Hello, everyone and welcome to the Graphics Packaging’s Third Quarter 2023 Earnings Call. All lines have been placed on mute during the presentation portion of the call with an opportunity for question and answer at the end. [Operator Instructions] I would now like to turn the conference call over to our host, Melanie Skijus, Vice Principal of Investor Relations. Please go ahead.

Melanie Skijus: Good morning and welcome to Graphics Packaging Holding Company’s third quarter 2023 earnings call. Joining us on our call today are Mike Doss, the company’s President and CEO, and Steve Scherger, Executive Vice President and CFO. To help you follow along with today’s call, we will be referencing our third quarter earnings presentation, which can be accessed through the webcast and also on the investors section of our website at www.graphicpkg.com. Before I turn the call over to Mike, let me remind you that today’s press release, the third quarter earnings presentation and the statements made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

A close-up view of a hand assembling boxes of industrial packaging on an assembly line.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the risks identified in the release and the presentation, as well as our filings with the Securities and Exchange Commission. With that, I’ll turn the call over to Mike.

Michael Doss: Thank you, Melanie. Good morning, everyone and thank you for joining us on the call today. Let’s begin with a highlight on slide 4. I’m very proud of our team’s performance during the third quarter amid a very dynamic environment, we continue to make progress on our goals, deliver adjusted EBITDA growth and margin expansion, invest for the future and fulfill our purpose to package life’s everyday moments for a renewable future. As customers have pointed out in recent months, the consumer environment remains dynamic, and uncertain and evolving macroclimate has resulted in a relatively more cautious consumer in the near term. At the same time and as we have discussed last quarter, retailers are operating with more normalized inventory levels versus a year ago, as supply chain challenges have largely subsided.

The combination of these factors has had a modest impact on our packaging volume. In listening to a broad mix of our global customers and given the confidence we have in our innovation pipeline; we are anticipating a return to our targeted 100 basis points to 200 basis points of net organic sales growth in 2024. Responding to external factors, our team leveraged the scale and flexibility inherent in our system and reduced paperboard production by 150,000 tons during the quarter. Through our disciplined commercial approach and active management of supply to meet demand, we met our commitments to customers and stakeholders while adopting to current volume changes. Together, our team, our capabilities in our strong operational execution provided the path to targeted EBITDA margin levels in the quarter.

Our performance demonstrates the resilience of our business and is a testament to our differentiated approach to servicing and growing consumer packaging markets. We are delivering value to customers with the packaging solutions we provide and optimizing our system to position Graphic Packaging for the long-term growth. The key element of our strategy is supporting growth through advancing innovation capabilities and making strategic investments. We make considerable progress on this front in the third quarter, including new innovations that are driving category and market expansion, continued progress on our multi-year CRB system transformation, both of which I will expand on in a moment, and lastly, the completion of the Bell Incorporated acquisition.

The acquisition of Bell is a good example of how we are investing in our packaging network by adding capabilities, and expanding the customers and markets we serve. Acquisition integration is well underway and we are excited about the new opportunities Bell provides. As we look ahead, we are positioned to benefit from the long-term strength of demand for sustainable fiber-based packaging. We are focused on further distinguishing Graphic Packaging as the leader in recycled and recycled full consumer packaging. We have updated our guidance and continue to expect 2023 adjusted EBITDA of $1.9 billion at the midpoint of our guidance range. In addition, we are tracking to meet or exceed our enhanced vision 2025 financial goals. We remain confident in our ability to achieve annual organic sales growth targets in the years ahead.

One of the many reasons we remain confident in our organic growth outlook is the continued advancements we are driving through innovation with our customers. Slide 5 provides another example of our innovation engine at work and the continued progress using fiber to replace packaging previously created with non-renewable resources like plastic and foam. I’m sure many of you recognize the iconic Nissin Cup Noodles, a leading brand in the Ramen comfort food category. Historically, the noodle cups have been made of foam. Through our innovation capabilities and expertise in both food service and retail packaging, the fiber-based solution we developed serves as a more sustainable packaging alternative to foam and is effective in a shelf-stable retail environment.

Notably, our retail cup solution for Nissan provides added convenience for the consumer as it is safe for microwave use, eliminating an extra step required in meal preparation when using foam. We are excited to share with you today a new partnership we have with Nissan Foods and the upcoming launch of their Cup Noodles product, packaged in our proprietary retail double wall fiber-based cup solution. The rollout is expected to begin in the first quarter of 2024. Aligned with consumer preferences for more sustainable packaging options, Nissan plans to convert their entire 16-ounce cup noodles product line in the U.S. from foam to our solution over time. This packaging application marks our first in microwave cups as we continue to expand the addressable market within the more than $4 billion cup and container market in the U.S. Our history-serving retail markets and our ability to invest behind in scale with customers creates new opportunities across various dry food categories that today are primarily in foam and plastic.

Items such as pasta, hot cereals, breakfast mixes and single-serve dried foods are examples, where our fiber-based solution has tremendous potential to win. While discussing growth opportunities in the broader cup market, let me also provide an update on our program, Chick-fil-A. Last quarter, this important customer went to market with our new, highly-insulated double-wall beverage cup and approximately, 10% of its stores as a potential long-term solution for its beverage program. Feedback from both stores and consumers has been favorable and phase 1 of the program continues with rollouts currently underway to additional stores. We continue to believe our innovation can be a long-term solution for Chick-fil-A and others currently using foam cups in containers.

Frightening innovation with industry leaders like Chick-fil-A and Nissan Foods demonstrates how top brands are investing to transition toward more sustainable packaging solutions. Through our extensive design and packaging network, we are partnering with leading brands to effectively transition to sustainable packaging solutions that consumers prefer. We believe long-term tailwinds support the continued demand of this transition, such as end-use consumers seeking more sustainable packaging, customers responding to demand in pursuing sustainability goals and in a growing number of jurisdictions, environmental legislation requiring the use of more sustainable packaging. Moving to slide 6. let me provide a brief update on the significant progress we have made on our CRB transformation.

Since 2019, we have embarked on a multi-year optimization effort to simplify our CRB system, while strategically expanding capacity and lowering cost. The end result will further distinguish Graphic Packaging as the lowest cost and highest-quality coated recycled paperboard produced in North America. Our efforts to optimize and strategically expand capacity are the result trends we identified early on, including growing consumer demand for packaging made from recycled materials. Our focused investments will ensure we will sustain unmasked quality and cost advantage in this important category for years to come. Since the project began, we have made significant progress in our CRB system transformation, with our new 550,000-ton K2 machine ramped in Kalamazoo, we have effectively increased our net CRB capacity by 70,000 tons to support our growth.

Through higher costs, less efficient facilities and our longest-running paperboard machine in Kalamazoo, the total production of 480,000 tons have been removed from the system. As noted, this total includes our recently-announced permanent decommissioning of the K3 machine. Our decision on K3 reflects the incredible success of the state-of-the-art K2 machine, which has been operating at or above committed efficiency and quality levels. We look forward to replicating the success of K2 with our new CRB paperboard machine in Waco, Texas, which will expand upon our quality and cost advantages when it begins production in late 2025. As we have talked about before, the ability to cost-effectively produce higher-quality CRB allows us to meaningfully and profitably expand opportunities within new markets and ones we already serve.

One example of this quality improvement is the new pay center reviewer recycled paperboard, which we introduced last quarter. This new grade of the highest quality recycled paperboard available will facilitate CRB and more consumer packaging experiences across the food, health, pharmaceutical and beauty product applications. We are pleased to have our first sale of pay center in the year in October and look forward to sharing many more packaging example wins in the quarters to come. The third quarter also included the release of our 2022 ESG report detailing the progress we have made towards achieving our vision 2025 ESG goals. Sustainability is an integral part of our business strategy and our impact extends well beyond our own business. We enable customers, including many of the world’s leading household brands, to transition towards recycled and more recyclable packaging solutions.

I’d like to note a few key highlights from the report that can be seen on slide 7. To start, we successfully achieved our goals for greenhouse gas emissions intensity and non-renewable energy intensity three years early. We did so through investments in efficient manufacturing and expanding the scale of our packaging operations. For example, the K2 machine helped reduce emissions intensity associated with CRB production by an estimated 3% in 2022. We also highlighted we are on track with our goal to have 100% of our global facilities compliant with a fiber certification standard. Forest certification and certified sourcing programs give consumers confidence that our packaging does not contribute to deforestation or biodiversity loss. The goal demonstrates our support for sustainable forest management and forest product sourcing practices we follow to ensure compliance.

We have more than 24,000 teammates worldwide and I am proud of the progress we are making as we build a more diverse and inclusive workforce. There is always more work we can do and we remain committed to fostering continuous improvement in the workplace centered around our employees’ growth and sense of belonging. Slide 8 highlights a recent sustainability achievement I am very excited to share with you. We learned in early October that the science-based targets initiative approved our 2032 carbon reduction goals, which are outlined here. As an increasing number of consumers are voting with their wallets by purchasing products and brands that are doing the right thing for the planet, we are proud to be filling our purpose to package life’s everyday moments for a renewable future.

With that, I’ll turn the call over to Steve to provide more detail on the financial results. Steve?

Stephen Scherger: Thanks, Mike and good morning. Let me start on slide 9 with an overview of the key financial highlights for the third quarter and the first nine months of 2023. Overall, our results demonstrate the resiliency of our business and ability to operate effectively through a very dynamic macro environment. Net sales declined 4% year-over-year to $2.3 billion. As Mike discussed, sales during the quarter were impacted by some fluctuations in consumer purchasing behavior and by efforts from retailers to adjust inventory levels. Those headwinds will partially offset by positive pricing execution in the impact of foreign exchange. Net organic sales growth adjusted for the same number of shipping days as in the prior-year period, was down 4.6% during the quarter.

We now expect net organic sales to be plus or minus 2% in the fourth quarter, with an anticipated return to our targeted 100 basis points to 200 basis points of net organic sales growth in 2024. We remain confident in our innovation pipeline and our ability to execute on commercial opportunities to fuel our organic growth in the years ahead. Our expected four-year cumulative average organic sales growth rate of approximately 2% from 2019 to 2023, remains at the high end of our annual range, established with Vision 2025. Our top-line performance is benefiting from our diverse portfolio of end markets and customers. While sales for the food, beverage and consumer markets decreased 6% in the quarter from the prior-year period. sales in our food service markets grew 8% as our packaging solutions continue to win as mobile consumers are looking for convenience when eating and drinking on the go.

We are actively managing our supply to meet current demand, exercising discipline and production while minimizing the cost of doing so, and focusing on servicing long-term customer relationships with their packaging needs. Given the disciplined approach to production, we exercise throughout our packaging business. Reported profitability is as strong as we anticipated despite short-term fluctuations in the consumer environment. Adjusted EBITDA grew 9% year-over-year to $482 million and adjusted EBITDA margins expanded by 250 basis points year-over-year to 20.5%. Adjusted EPS also continued to grow expanding to 10% year-over-year to $0.74. As a reminder, our sales and EBITDA waterfalls are available for reference in the appendix of today’s presentation.

Global liquidity remains strong at nearly $1.2 billion. Our success driving integration rates higher was evident in the quarter with paperwork integration into our consumer packaging business at 79%. This is an increase of 500 basis points from the prior-year period. As a reminder, this is an increase of 1,200 basis points from 67% since January 2018 when we completed a combination with International Paper’s North American Consumer Packaging business. We will continue to drive integration rates higher as we capture and execute growth opportunities in consumer packaging. Slide 10 outlines updated full-year guidance for 2023, reflecting our current expectations, as well as the recent acquisition of Bell Incorporated. Most notably, the midpoints of our adjusted EBITDA and adjusted EPS guidance remain fundamentally unchanged.

Turning to slide 11. We continue our balanced approach to capital allocation, which focuses on growth and capital return. As discussed during today’s call, we remain focused on investing for growth, such as the recent acquisition of Bell, ongoing advancements in innovation and the new recycled paperboard facility in Waco, while also reducing leverage to the lower end of our targeted range and returning capital to shareholders. As of today, we have repurchased $54 million of stock year-to-date. Our balanced approach to capital allocation positions the business for continued success and delivers value for stakeholders. With that, I will turn the call back to Mike.

Michael Doss: Thanks, Steve and I’d like to thank our talented team around the globe. Their strong execution positions Graphic Packaging to meet our commitments to customers, deliver value for stakeholders and continue our leadership in fiber-based consumer packaging. I am pleased to share with you that we will be hosting an Investor Day in New York on February 21st, 2024. In addition to a strategic update on the business, we will provide Q4 and full-year 2023 financial results, guidance for 2024 and looking further into the future, our new Vision 2030 aspirations and goals. We are excited to see many of you in-person and look forward to providing more details on our plans for the future. I will now turn the call back to the operator to begin the question-and-answer session. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] So, our first question comes from the line of Ghansham Panjabi of Baird. Your line is open. Please go ahead.

Ghansham Panjabi: Thank you, operator. Good morning, everybody. Mike, so just kind of looking back at 2023, it seems like this was the year price cost led margin expansion and just much weaker than forecast end markets given destocking and some level of consumer elasticity that perhaps offset many of your internal growth and productivity initiatives. Based on what you see at this point, what does 2024 look like? Would it be just better volumes just based on the comparison and some level of margin give back based on the pricing trend line in the industry and then maybe as a correlate to that for Steve, any variances you can share with us on an EBITDA basis such as price cost for ’24?

Michael Doss: Good to hear you. We heard a little break up there, but I think I got the gist of your question talking about volumes here in 2023. how we’re thinking about them and kind of the — as we’re exiting ’23 and then to ’24. And I’d say this, I mean, as we told you, going into this quarter, our third quarter, this is going to be the toughest quarter [Technical Difficulty] versus ’22, we’re up almost 5%. And today’s adjusted basis, we came in and clapped with second quarter, really what we communicated at the end of the second quarter. So, pretty much in line with what we thought. And our comps get a little easier here in Q4. We were up a little less than 1% last year in Q4. So, we’ve got a range out there of minus 2 to plus 2.

And really the real reason for that, as you know is the recovery is just not linear. It tends to be a little bit lumpier than anybody says. And from our standpoint, our crystal ball is no better or worse than anybody else’s in terms of when the actual inflection occurs. We have some customers that are talking about an elongated recovery. We have some customers that are talking about promotions that are going to occur in Q4 and dry volumes. So, it’s a balance between those two things. They give us confidence as we head into ’24 around our ability to grow at our medium to long-term and we can put out there 100 basis points to 200 basis points of growth. The first, of course, just the costs get easier, coming off of this year. So, that’s point number one.

Point number two is we’ve got a very robust and deep innovation pipeline. Examples like we gave here today, the cup noodles and the Chick-fil-A, cold and gold cups, and there’s been others almost every one of our updates. So, we point to another thing that we’re doing out there to replace usually plastic or foam into fiber-based packaging. So, we know we’ll grow with our innovation. And then second — or the third point that I’d make is that’s really what our customers are telling us. They need to grow too, because ultimately, their stocks don’t work if they don’t have top-line growth that also translates into volumes as well. So, those three things really give us confidence as we go into 2024. Now exactly, what’s going to happen in Q1? Probably not, but our confidence is high that in ’24, it will grow again.

And if you really take a step back to over a four-year period of time and you just say we’re at the midpoint of our guide for volumes here in Q4, we grew a 3% a year for the three years coming into this year. This year, we take a step back 2%, maybe 2.5%. But if you look at a four-year stack on that, we’re at our 2% target that we put out there. It’s high end of the 100 basis points to 200 basis points. So, we knew over a long-term aspiration goal that we put out like Vision 2025, there’d be some ups and downs that occurred. But overall, we’re very pleased with the overall trajectory and the growth that we’ve experienced in the business and expect that to continue in ’24.

Stephen Scherger: And Ghansham, this is Steve, you want to just repeat a little bit of your — about ’24 just to make sure I’ve got it right?

Ghansham Panjabi: Yes. I was just curious on the variances on EBITDA, on price cost, and whatever else you can share at this point.

Stephen Scherger: Yes. Thank you for that. I just wanted to make sure that’s what I thought you said. I mean, listen, as Mike just said, if we look into the ’24, there’s some real positives that we would expect will be beneficial to the P&L if you kind of look out to next year. We’ll have a full year of the Bell acquisition. We acquired that in the fourth quarter, so modest EBITDA this year. Just by way of reminder, we bought $30 million of EBITDA and $10 million of synergy. So, we’ll pick up probably incremental $20 million from that next year along with the synergy. So, think of that as a plus $30 million [Technical Difficulty] will earn on 100 basis points to 200 basis points of organic sales growth and you know what that value perspective would be at or above our margins as we generate.

And we should have a very strong productivity here. We will have less planned maintenance [Technical Difficulty] have less market-related downtime as we return to growth. And [Technical Difficulty] weather-related, the bet that was of substance, which certainly, we don’t plan for that to repeat. So, those are three very positive benefits as we go down [Technical Difficulty] labor benefits and inflation this year running a little bit higher than normal. We’d expect that to get back to the levels. And if you mark to market the current price cost environment, so just mark [Technical Difficulty] and all of it pricing related, $80 on SBS, the $20 on [Technical Difficulty]. We’re in a very benign inflationary environment here [Technical Difficulty] obviously, as we’ve talked, we’re very committed to operating the company through narrow range of EBITDA margins.

And this year, we moved towards the 20%. And certainly, we would expect operating a pretty thin band around that 20% as we look out to 2024. So that gives you some of the components. We’ll obviously provide detailed guidance when we’re together in February and provide that to you in a more granular level. But those are, I think, the high points if you kind of look at the year ahead.

Ghansham Panjabi: Perfect. Thank you so much. I’ll turn it over.

Michael Doss: Thanks, Ghansham.

Operator: Thank you. Our next question comes from the line of Mike Roxland. Your line is now open. Please go ahead.

Mike Roxland: Thank you, Mike, Steve and Melanie for giving my questions and congrats on the good quarter despite the backdrop. On your last call, you mentioned contract resets, particularly in North America, which have long duration in two years to five years. And you mentioned, I think, the way you phrased it was that there’s a meaningful number of contracts out there that you still could be addressed over the next 12 months to 24 months that have yet to reflect the higher prices. So, is there any way that you could help us size that? Is that 20% of all contracts, 30% of all contracts? And the reason I’m trying to just drill down on that is because Steve just answered the prior question on some of the drivers for 2024, but wouldn’t those contract resets also be beneficial to driving EBITDA growth next year?