Graphic Packaging Holding Company (NYSE:GPK) Q2 2023 Earnings Call Transcript
Graphic Packaging Holding Company (NYSE:GPK) Q2 2023 Earnings Call Transcript August 1, 2023
Graphic Packaging Holding Company misses on earnings expectations. Reported EPS is $0.6 EPS, expectations were $0.73.
Operator: Hello and welcome to the Graphic Packaging Second Quarter 2023 Earnings Call. My name is Elliot and I will be coordinating your call. [Operator Instructions] 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 second 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 second 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 second 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.
These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and objections. These risks and uncertainties include, but are not limited to, the risks identified in the press release and the presentation as well as our filings with the Securities and Exchange Commission. With that, I will turn the call over to Mike.
Mike Doss: Thank you, Melanie. Good morning, everyone and thank you for joining us on the call today. We delivered solid results during the second quarter while actively managing supply to meet demand. Importantly, our global team continued to advance key strategic initiatives to drive sustained future organic growth and higher profitability through commercial execution, quality improvement and cost reduction. Subsequent to the strategy is the strength of our packaging network and our ongoing efforts to ensure Graphic Packaging is the lowest cost, highest quality paperboard producer in North America focused on consumer packaging globally. The second quarter demonstrated both the advantages of our global network and our continued actions to build upon our leadership position.
Starting with highlights on Slide 3. Our confidence in the long-term strength of the demand for renewable and recyclable fiber-based packaging is high. As a result, we remain focused on strategically expanding capacity across our network to service this demand while lowering costs, improving quality and enhancing our innovation capabilities. We continue to optimize our network and will maintain important flexibility to manage production to the demand environment. This flexibility enables us to respond to short-term changes in demand, such as the customer and retailer inventory destocking that has taken place across the industry in recent months. By actively managing supply to meet demand and our commitments to a disciplined commercial approach, we are meeting the needs of customers and delivering results for stockholders, while adopting to fluctuations in demand.
The short-term destocking dynamic does not impact our confidence in the opportunity for long-term sustained organic growth or our plans to invest strategically to best position Graphic Packaging to provide the renewable and recyclable packaging consumers prefer. I am pleased to report that our K2 machine investment, Kalamazoo, continues to meet the return expectations and the new recycled paperboard investment in Waco remains on track to become another cornerstone for our optimized mill system. The acquisition of Bell Incorporated, which we are pleased to announce today, is another example of a strategic investment we are making in our packaging network. The pending acquisition, we had three new packaging facilities, increased our integration rates and expand the customers and categories we serve.
As we invest in growth through both strategic M&A and capital investments, we remain focused on returning capital to stockholders as an important part of our balanced approach to allocating capital. We are pleased that the Board of Directors has approved a $500 million increase to our share repurchase authorization, making a total of $590 million available for potential future share repurchases. Finally, we are reiterating our full year 2023 guidance and remain on track to meet or exceed our enhanced Vision 2025 financial goals. Our innovation engine continues to increase and diversify opportunities for consumer experiences with fiber-based packaging as we work with customers to deliver sustainable packaging that consumers prefer. Because of this long-term trend towards more recyclable and renewable packaging, we remain confident in our ability to drive 100 to 200 basis points of net organic sales growth annually for years to come.
Slide 4 captures our key financial metrics for the quarter. Second quarter sales increased 1% to $2.4 billion, with adjusted EBITDA growing 14% to $453 million as margins improved 210 basis points. These results led to adjusted earnings per share of $0.66, a 10% increase year-over-year. Given the short-term destocking dynamic we faced in Q2, it is important to look at the year-to-date results, where sales increased 5%, adjusted EBITDA improved 26%, and adjusted EPS was up 31% year-over-year. It is helpful to view this quarter in the context of the supply chain disruptions that dominated the headlines a year ago. Retailers have not historically held high levels of packaged goods inventory in part because the products we package have expiration dates.
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In the middle of last year, however, many accumulated supplies to insulate themselves from potential shortages. 12 months later, we are seeing the offsetting effect of that buildup and slower organic sales as retailers and customers work through their inventory. We are actively responding to ensure we are keeping our inventory backlogs and operating rigs at appropriate levels. We have and will continue to utilize planned maintenance downtime, scale back production to meet demand and manage cost implications. Importantly, we have continued to realize the value of our packaging solutions in the marketplace, providing confidence in our ability to deliver sustained EBITDA margins in the 18% to 20% range. Looking ahead, we believe retailer destocking will be a relatively short-term headwind with normal customer order patterns and organic growth expected to return in the fourth quarter of this year.
On Slide 5, you can see examples of two key initiatives we expect will drive growth and category expansion and entirely new grade, the highest quality recycled paperboard available, which we call PaceSetter Rainier and our proprietary cup innovation that launched with Chick-fil-A during the quarter. PaceSetter Rainier is an innovation that will facilitate recycled paperboard in more consumer packaging experiences, thanks to the surface brightness and smoothness enhancements that historically have only been possible with virgin fiber substrates. While Rainier will be a great-looking package option for many food applications, we are also excited about its potential for health, pharmaceutical and beauty products that, for example, utilized packaging to hold a pill bottle or a blister pack.
Health and beauty customers prioritize packaging appearance and readability. We will continue to look for opportunities to win in this large market with our lower cost packaging solution made from recycled materials. Customer trials for PaceSetter Rainier are underway and we have received excellent feedback on the quality of this new innovation. We are focused on driving continued packaging trials with customers and plan to ramp up production in the second half of the year and into 2024. Last quarter, we announced our longstanding customer, Chick-fil-A, was going to market with our new highly insulated double-walled cup as a potential long-term solution for their beverage program. 3 months later, the rollout to 10% of their stores is on track and going well with excellent feedback from Chick-fil-A and their consumers.
Our proprietary fiber-based cup has a number of distinct advantages that allow us to operate similar to the phone cup. It utilizes a built-in insulated sleeve that controls condensation, increases the rigidity and is made with sustainably sourced material. Turning to Slide 6, you can see our current paperboard mill network with the production strategically located near our packaging facilities. Our newer K2 machine in Kalamazoo, utilized leading-edge technology and produces the highest quality coated recycled paperboard for consumer packaging in the world. The new machine in mill campus is a crucial part of our network that gives us flexibility to optimize our CRB production to meet packaging demand. The success in Kalamazoo is an important example of our long-term strategy of driving organic growth and delivering strong returns on capital investments.
We believe the strategically located Waco recycled paperboard mill will also deliver tremendous cost and quality benefits when completed in late 2025. Progress at the Waco site continues with a number of milestones achieved, including key mill management roles have been filled, 85% of the equipment has been ordered foundations and floor pads completed for the finished goods warehouse and we are pouring concrete for the recycled fiber warehouse floors. These investments support growth, drive down costs and advance our position as the leading fiber-based packaging company focused on consumer markets. On Slide 7, you can see details of the acquisition we announced today. Bell Incorporated is a family-owned packaging company that has been in business for over 40 years.
It operates 3 packaging facilities in South Dakota and Ohio. The acquisition strategically expands our packaging network and customer base in North America while also increasing integration rates. Bell provides packaging to a host of household names and we are particularly excited the acquisition will expand Graphic Packaging into the fiber-based consumer mailer category, where Bell has a substantial presence. In terms of financials, Bell has annual sales of approximately $200 million and EBITDA of $30 million. The acquisition cost is approximately $260 million and we estimate annual synergies of approximately $10 million over 24 months. We expect the acquisition to close in the fourth quarter. Turning now to Slide 8. Consumers are showing a preference for plastic packaging and alternatives made from fiber-based materials and are using their purchasing dollars to support brands that are doing the right thing for our planning.
Increased consumer demand creates a tremendous opportunity to partner with our customers on innovative packaging that resonates with end users. On the slide, you see examples of products that our development team is working on as we actively expand and deepen our presence in food, foodservice, beverage and other consumer markets. Our integrated packaging platform and product development approach, which always keeps the consumer in mind, are key differentiators and how we are running at different rates. We are actively pursuing a $12.5 billion addressable market, of which $11 billion is represented by plastic and foam packaging replacement opportunities. In summary, our operational execution, advancements in innovation and investments to strengthen and strategically grow the business, all give us confidence that we will continue to drive 100 to 200 basis points of annual net organic sales growth in the years ahead.
With that, I will turn the call over to Steve to provide more detail on the financial results. Steve?
Steve Scherger: Thanks, Mike and good morning. Turning to Slide 9 and the results for the second quarter and first half of 2023. Q2 was solid, building on first quarter results and a strong start to the year. Net sales increased 1% year-over-year to $2.4 billion, with positive pricing, partially offset by a decline in net organic sales and lower open market paperboard volume. For the first half of the year, net sales of $4.8 billion increased 5% over the first half of 2022. Net organic sales in the first half were lower by 2% from the prior year period due to inventory destocking in the quarter, as Mike discussed earlier. We see these moves by customers and retailers to normalize inventory levels as relatively short term and expect to return to organic sales growth during the fourth quarter.
Consistent with our track record of organic sales growth over the last few years, we remain confident in our ability to capture new packaging opportunities and deliver net organic sales growth. Our expected 4-year cumulative average organic sales growth rate of 2% for 2019 to 2023 is at the high end of our targeted 100 to 200 basis point annual range established with Vision 2025. As you can see on the slide our second quarter consolidated sales benefited from our diverse portfolio of end markets and customers. The foodservice market, which represents approximately 20% of our portfolio, had a very strong quarter, growing 10% compared to the prior year period. Our food, beverage and consumer markets, which represent approximately 80% of our portfolio, experienced flat sales year-over-year.
Adjusted EBITDA was $453 million, up $57 million over last year. As a reminder, our sales and EBITDA waterfall are available for reference in the appendix of today’s presentation. Liquidity remained strong at over $1.25 billion. Importantly, our paperboard integration rate increased 9% during the quarter, up 500 basis points from the prior year period. January 2018, when we completed our combination with International Paper’s North American Consumer Packaging business increased integration rates from 67% to 79%. The pending is estimated to increase our integration rate by an incremental 200 to 300 basis points over the next 24 months. Our backlog averaged 4 weeks across all substrates and second quarter operating rates across the business remained in the mid-90s.
We were running our business to service customers at a high level while actively managing supply to meet their demand for packaging. Slide 10 features our full year guidance, reflecting growth across key performance metrics and a reduction in leverage to the low end of our historical targeted range. As Mike mentioned earlier, we are reiterating our financial guidance for 2023, including the increased expectations for adjusted EBITDA and adjusted EPS we provided last quarter. Guidance does not include the pending acquisition of. Turning to Slide 11. Our balanced approach to capital allocation, expectations for continued growth and significant cash generation support our prudent allocation of capital into initiatives that strengthen the business and drive future growth, while at the same time, provide a path to return to 2.5x or below by year-end.
In closing, we are investing in initiatives that support our Vision 2025 including today’s Bell Incorporated acquisition announcement, our investment in Waco and ongoing collaborative innovation projects with customers. We are resolute in our focus to drive profitable growth and extend our leadership position in consumer packaging while returning cash to stockholders through our dividend and potential future share repurchases. Thank you for your time this morning. With that, I will turn the call back to the operator to begin the question-and-answer session. Operator?
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