Graphic Packaging Holding Company (NYSE:GPK) Q4 2022 Earnings Call Transcript

Graphic Packaging Holding Company (NYSE:GPK) Q4 2022 Earnings Call Transcript February 7, 2023

Operator: Hello, and welcome to the Graphic Packaging Q4 and Full-Year 2022 Earnings Call and Webcast. My name is Elliot, and I'll be coordinating your call today. I would now like to hand over to Melanie Skijus, Vice President of Investor Relations. The floor is yours. Please go ahead.

Melanie Skijus: Good morning, and welcome to Graphic Packaging Holding Company's fourth quarter and full-year 2022 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 fourth 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 and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. 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 factors identified in the release and in our filings with the Securities and Exchange Commission. With that, let me now turn the call over to Mike.

Michael Doss: Thank you, Melanie. Good morning. Thank you for joining us on the call today. 2022 was an outstanding year of Graphic Packaging. We significantly grew our business and continued executing strategic initiatives focused on extending our leadership in fiber-based consumer packaging. Our focus on consumer packaging is driving profitable growth and delivering returns for shareholders in line with our Vision 2025 goals. Turning to Slide 4, let me walk you through the year's accomplishments and a brief look into 2023 before sharing the details of the exciting new strategic capital investment we are announcing this morning. Our financial results in both quarter and the full-year were excellent, characterized by strong growth and margin expansion.

Sales for the full-year increased 32% to $9.4 billion, driven by $1.1 billion positive pricing, 3% organic sales growth and acquisitions. Adjusted EBITDA of $1.6 billion grew in a faster pace sales of 52% as margins expanded by 210 basis points to 16.9%. New coated recycled paperboard or CRB K2 machine investment, the largest capital investment we have made today came to life in early 2022 as we successfully ramped production of the machine on our original timeline. The investment is evidence of our long-term commitment to high-quality, low cost production of fiber-based consumer packaging utilizing recycled content. The investment returned the first $47 million of EBITDA in 2022 and remains on track to achieve the total annual run rate of $130 million of incremental EBITDA in 2024.

The success this investment has provided us with the expertise the confidence to continue to strategically invest as we will detail further in a few moments. The AR Packaging acquisition in Europe continues to meet our high expectations. Growth opportunities provided by new consumer markets, geographic expansion and proprietary solutions protected by intellectual property have further accelerated our excellent momentum. Our combined team successfully integrated the business and the initial targeted $40 million synergy goal remains on track with the first $15 million realized in 2022. As committed, our net leverage ratio declined 3.2x at year-end from pro forma 4.6x at year-end 2021. Through new product innovations and expanded geographies, we increased the addressable market for organic growth of $12.5 billion from $5 billion just a few years ago.

We remain confident in our ability to achieve 100 basis points to 200 basis points annual net organic sales growth in 2023 and beyond, given strong demand from global customers for our robust pipeline of innovative fiber-based consumer packaging. Looking briefly into 2023, and as Steve will describe in his remarks, we expect sales for adjusted EBITDA and adjusted EPS to again grow year-over-year, generating strong cash flow we will invest for long-term value creation while having balance sheet prudent for today's uncertain economic environment. Before I walk through the details of the significant new investment we are announcing today, let me take a moment on Slide 5 to reflect on our performance over the past three-year period since announcing Vision 2025 in September 2019.

Our global team has successfully executed a pivot to sustainability supported organic growth with net organic sales up approximately 10% since 2019. We have pursued and achieved critical milestones on our journey to Vision 2025, including growing net sales, expanding margins and building a much larger scale business focused almost entirely on a fiber-based consumer packaging. Over the past three years, sales have grown by over $3 billion to $9.4 billion, representing a 15% compound annual growth rate. Adjusted EBITDA and adjusted earnings per share have expanded at a faster pace than sales driven by margin expansion. Our financial results and achievements over the last three years have resulted in a total shareholder return of 41%, outperforming the S&P 500 return by 1,600 basis points.

We are creating value through our leadership of Vision 2025. The investments we have made to advance our capabilities as a fiber-based consumer packaging company differentiate us. As you've heard me say before, we are running a different race. Let me now turn to Slide 6 to provide details regarding our announcement this morning and the role it will play in our long-term commitment to meeting consumer demand for sustainable package. Graphic Packaging is the only North American producer investing to meaningfully upgrade and expand CRB capabilities. We are confident this is the right strategy to deliver value to our customers and to our investors. We recognize the distinct opportunities that substrate can provide. The future of Consumer Packaging will include more CRB and more places, and we are taking steps to position our paperboard network to meet this growing demand.

We have a strong leadership position in CRB from a cost and capability perspective, and this investment will further these advances. We will be leveraging our unique expertise in CRB production, our from the recent K2 investment and our leading North American mill system to build a new CRB mill in Waco, Texas. Importantly, this investment not only enhances our CRB capabilities, but supports optimization of our full paperboard network and improves our environmental footprint to further distinguish Graphic Packaging as the low-cost highest-quality paperboard producer in North America. As a result, we expect to drive significant and sustainable EBITDA improvement well into the future. Referring to Slide 7, the growing demand for packaging made with recycled materials is driven by the consumer.

Today's consumer is more environmentally aware than ever. And according to a recent survey, consumers rank packaging made from the cyclical materials as the most appealing sustainability claim. Dual package made with CRB, consumers see the benefit of their recycling efforts each time they place a fiber-based packaging to a recycling bin. As you can imagine, our customers are responding to what consumers are telling them by seeking to use more recycled materials in their packaging. Not only is doing so in line with consumer trends and preferences is also a key driver for advancing their recyclability goals and support their overall publicly committed sustainability programs. This growing demand, combined with the improved quality of CRB produced by Graphic Packaging's modern mills utilizing the latest state-of-the-art technology is expanding the breadth of our opportunities for CRB-based packaging.

Slide 8 demonstrates how we believe this new investment will meet the increased demand for CRB at an unmatched cost compared to our competitors. As you can see, the addition of Waco allows us to further optimize our network by closing higher-cost mills over time while still expanding capacity to meet growing global demand. We expect the new machine in Waco will mirror the capacity and cost per ton of recently completed K2 machine Kalamazoo. It's clear to see that the modern technology inherent in these new machines provides meaningful cost to produce step-change improvement compared to the decades-old machines used elsewhere. Notably, this expansive competitive cost differentiation is unique to the CRB substrate as compared to other fiber-based substrates.

We are building for the future in a manner that is far more efficient than what was built in the past. Turning to Slide 9. In addition to the efficiency of the mill itself, we are very excited to have secured a location that is ideally positioned within a growing economic center. The city of Waco is situated in the Texas Triangle. Our new mill will be strategically located within 200 miles of approximately 80% of the population in Texas providing easy access to a strong existing recycled fiber basket. Waco also has existing infrastructure to support a mill as well as advantaged logistics from a rail and roadway perspective to supply our packaging facilities and our customers. We are looking forward to joining the Waco community and working with the great talent base in the area.

We appreciate the strong support and engagement we have received from the city and the county as we conducted our site selection process. From a timing perspective, we expect to start construction this quarter and begin commissioning the machine by the end of 2025 with production ramping up in early 2026. Our decision to build this mill shortly after K2 allows us to leverage key learnings from that process, both internally with our external partners, which gives us added confidence in our ability to meet the projected timeline and quickly ramp-up production on the new recycled paperboard machine. Slide 10 shows an updated map for our current future mill network. With this new investment and targeted mill closures, we are looking at a simplified and optimized mill network that will lower cost and strategically increase capacity.

Our virgin paperboard mills are located throughout the Southeast, which is the best virgin fiber basket in the country. Our two industry-leading CRB mills in the future will be geographically located to provide strong coverage across the United States as well as in Canada and Mexico. We estimate the optimized mill network will have 5% more capacity than we have today with the flexibility to adjust capacity in line with demand. Importantly, while the capacity expansion is driven by the addition of the new Waco mill, the benefits run across other substrates. The improved CRB quality made possible by our new machines will enable substrate optimization across our mill system as some packages that historically require virgin fiber can now be made with CRB.

This will free up incremental virgin capacity in our other mills to meet our growing global demand. The combination of our global packaging growth plans and our mill network optimization plans will support integration rates in excess of 90% once the new mill is in operation. Overall, this investment will extend our position as the lowest cost, highest quality paperboard producer in North America. Beyond cost quality and capacity there are also significant sustainability advantages to this new investment as outlined on Slide 11. First, we will be increasing circularity of our system through an enhanced drum pulper investment. This investment increases our ability to clean and separate a broader range of secondary fibers. Today, a large percentage of our paperboard waste that we cannot recycle is exported.

Our Waco mills designed to enable the recycling a 100% of our own internally generated paperboard side rolls and waste. We plan to capture the value of that fiber as well as reduce the environmental impact of shipping the fiber offshore for processing. We are estimating around 200,000 tons of side rolls and waste will be processed at the Waco mill versus purchasing external secondary fiber as we do today. This will also significantly enhance the security of the secondary fiber supply. This machine also increases our paper cup recycling ability. The drum pulper has the capacity to process up to 15 million paper cups per day. To take advantage of this increased recycling capacity, we have launched teams to engage with our customers and recycling partners to increase the collection rate of paper cups to further support recovery and a more circular economy.

As you would expect, initial interest from customers is very high. Additionally, the CRB mill network optimization is expected to improve our environmental footprint. Our absolute greenhouse gas emissions are expected to decrease in our optimized North American CRB mill network by 12%. Investments in technologies such as the gas turbine to generate all electricity needed by the mill as well as produce steam for paperboard drying will improve overall efficiency and reliability. Lastly, let me cover the financial highlights of the project on Slide 12. This approximately $1 billion investment will be internally funded with operating cash flow over the course of three years and is consistent with our balanced approach to capital allocation. We have flexibility to invest in our business and have a strong balance sheet with manageable debt levels.

As Steve will detail further, we remain focused on continuing to reduce our net leverage in 2023. We expect the state-of-the-art mill will generate $160 million of incremental annual EBITDA at its full run rate, driven by approximately $100 million of cost reduction and $60 million benefit through optimized mill capacity. We expect to realize approximately $80 million in the return on the investment in 2026, the machine's first year of operation. In summary, the strategic investment showcases how we are extending our leadership in fiber-based consumer packaging to meet growing demand for more sustainable packaging solutions. With that, I'll turn the call over to Steve to provide more detail on the quarter and full-year financials along with 2023 guidance.

Steve?

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Photo by Remy Gieling on Unsplash

Stephen Scherger: Thanks, Mike, and good morning. Turning to Slide 13 and the key financial highlights for the fourth quarter and full-year. Net sales increased 20% in the fourth quarter to $2.4 billion and 32% for the full-year to $9.4 billion. Fourth quarter net organic sales growth of a 1% was in line with their expectations as our customers manage year-end inventory position resulting in full-year net organic sales growth of 3%. This represents our third consecutive year of delivering organic sales growth at or above the high-end of our targeted range. Q4 adjusted EBITDA of $413 million increased to $128 million or 45% year-over-year, meeting our expectations despite the $20 million unfavorable impact from the late December winter storm, which impacted paperboard production by roughly 40,000 tons during the month.

Adjusted EBITDA margin of 17.3% improved to 300 basis points from the prior year period. Full-year adjusted EBITDA of $1.6 billion increased to $544 million or 52% from 2021. Adjusted EBITDA margin of 16.9% was up 210 basis points year-over-year. Adjusted EPS excluding amortization of purchase intangibles, continue to expand, growing 78% for the full-year $2.33. On Slide 14, let me walkthrough additional details of financial performance, markets, operations and capital allocation. Our food, beverage and consumer sales grew 37% in 2022, driven by positive price, organic sales growth and acquisitions. Full-year sales were up 16% before acquisitions. Foodservice sales also achieved strong growth of 25% from 2021. Significant growth in both sales and adjusted EBITDA were driven by positive pricing, organic sales growth and acquisitions partially offset by unfavorable foreign exchange.

Full-year adjusted EBITDA was also positively impacted by $47 million from the K2 CRB investment and $15 million in synergies realized from the AR Packaging acquisition. These positive benefits were partially offset by supply chain challenges and costs that our teams successfully managed throughout 2022 in order to meet customer demand. For your reference, our sales and EBITDA waterfalls are available in the appendix of today's presentation. Turning to paperboard market data. Industry operating rates reported by the FPA remained solid across substrates in the fourth quarter. SBS was 91% and CRB was 95%, our CUK operating rate remains over 95%. Company backlogs of seven to eight weeks remain healthy and are reflective of a balance supply demand environment.

During the year, our strong cash flow engine really was on full split. In addition to investing strategic capital to grow our business, we return capital to shareholders while significantly delivering our balance sheet. Net debt declined by $526 million to $5.1 billion and as committed, we reduced leverage to 3.2x at year-end 2022 from pro forma of 4.6x at the end of 2021, a significant achievement. Liquidity remains very strong at over $1.5 billion. As a reminder, our Board of Directors announced a quarterly dividend increase to $0.10 per share that was affected in January, 2023 given the strength of our cash flows and the progress we have made toward achieving our Vision 2025 goals. On Slide 15, let me provide our guidance for 2023. Many of the positive drivers that fuel growth in 2022 will continue in 2023.

We believe net organic sales growth driven by innovative packaging solutions, positive pricing, returns from the K2 investment, synergy capture, and core productivity will drive financial performance improvements year-over-year. 2023 sales are expected to grow over $500 million to approximately $10 billion. Adjusted EBITDA is expected to be in a range of $1.7 billion to $1.9 billion, reflecting an increase of 13% or $200 million at midpoint. Adjusted EPS excluding amortization of purchased intangible is expected to increase to a range of $2.50 to $2.90 per share. We expect to generate robust cash flow of $600 million to $800 million, which includes an initial $250 million to $300 million investment to support the new CRB mill in Waco, Texas.

We are targeting further reduction in our net leverage ratio to approximately 2.5x by year-end. Slide 16 presents strong progress we have made toward achieving our Vision 2025 goal over the last three years. Our 2023 guidance reflects momentum in the business towards achieving the enhanced financial goals, we established last February. We expect to further expand our margins, grow returns on invested capital, increase our paperboard integration rate and deploy capital to support growth and reduce costs. Finally, let's move on Slide 16. We believe Graphic Packaging is well positioned to consider pursuing an investment grade credit rating, our leadership position and progress today achieving Vision 2025 growth and return milestones coupled with our confidence in the sustain future cash flows of the business, provide us with the flexibility required to continue to invest for growth while pursuing an enhanced credit rating.

We will be engaging with the rating agencies in 2023 to assess options and the associated benefits of a potential upgrade. Thank you for your time this morning. I will turn the call back to Mike for closing remarks.

Michael Doss: Steve, thank you. Building on Steve's comments, cash flow generation in our business is significant and provides the means and financial flexibility to make investments such as the new CRB mill in Waco, we announced today while simultaneously further reducing debt and exploring an investment grade credit rate. Let me now wrap up my prepared remarks on Slide 17. Through our established track record of delivering net organic sales growth and productivity gains, along with our long history of deploying capital strategically to strengthen and grow the business, we are creating value for all stakeholders. We are executing strategic initiatives that answer the call from consumers from more sustainable packaging options and expanding the breadth of consumer packaging solutions we offer.

As a pure-play, global private base consumer packaging leader, we are running a different race. Thank you for your time this morning. Let's turn the call back to the operator now to begin the question-and-answer session.

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