Overview
Graphic Packaging Holding Company (NYSE:GPK) is a comprehensive supplier of paperboard and integrated paperboard packaging solutions to multinational beverage and consumer products companies. The 1Q23 results showed that management could execute at a high level, with steady volumes and gross margin despite the erratic demand environment. The fact that management is actively seeking out new opportunities to boost the company’s competitiveness and lengthen its growth runway is also encouraging. Given the cyclical nature of the industry and the price/cost lag in FY23, I anticipate this short-term tailwind for GPK to persist. In addition, GPK is trading at a historically attractive 8.5x forward price to earnings ratio, which is close to its all-time low valuation. I recommend a buy rating.
1Q23 earnings
GPK reported a higher-than-expected adjusted EPS of $0.77 for 1Q23. The company reported $484 million in adjusted EBITDA. Higher price realization, up 67.4 percent year over year, was the primary contributor to the positive delta. Additionally, the positive delta was aided by a 15.4% drop in commodity costs. The EBITDA margins improved by 430 basis points from the previous year to 19.9%. The decline in commodity prices was a major factor in the price increase that led to this improvement.
Growth
With organic sales volume increasing by around 1% in the quarter, underlying demand continues to be strong and trending positively. As impressive as this is, growth could be even more rapid if it weren’t for the unscheduled maintenance outage at West Monroe. Looking past the surface, organic growth in the quarter was driven in part by Europe, where it is over-indexed to consumption at home and where GPK is gaining market share thanks to rising demand for sustainable innovations and an increase in its share of consumer spending. The latter is an area where I continue to have optimism as sustainability-driven shifts into fiber are driving up demand for paperboard substrates. In light of management’s comments that operating rates for CRB and CUK are 95% and backlogs are at a healthy 6 weeks (earnings call is in May, so another 6 weeks is until mid-June), I believe that demand in 2Q23 should be pretty safe. Assuming GPK’s second quarter results are similar to its first, I see no reason why the company won’t be able to meet its FY23 revenue guidance, especially given the visibility I see into 2H23 demand. To return to the trend toward fiber-based approaches, I have faith in the $12 billion in incremental TAM opportunity over the long haul. Management expressed high hopes at the Goldman Sachs Industrials and Materials Conference for the upcoming trial with Chick-Fil-A. If this works, GPK will have more tools in its toolbox to take on this market. Accompanying the volume growth is pricing tailwinds. During the Goldman Sachs Industrials and Materials Conference, it was highlighted that GPK is well-positioned to benefit from the ongoing favorable pricing environment. The company has increased its overall realizations thanks to its successful renegotiation of cost-based contracts.
Competition
Risk of competition is a concern as end product is a commodity. However, I have faith in GPK’s ability to compete because of its dominant position in the market, where it and its main rival hold a large majority of market share (Goldman Sachs Industrials and Materials Conference). Since the final product is a commodity, economies of scale play a significant role. This allows large players to have structurally lower cost per unit, which is a winning factor. Competing on the same level will be incredibly difficult for subscale players. Importantly, GPK has an advantage in the market because it can provide its customers with scale and a reliable supply, both of which are hard to find elsewhere. Management has also pointed out that European manufacturers with export plans to North America will be at a disadvantage due to higher domestic mill network freight, fiber, and energy costs.
Guidance
As a result of 1Q23 price execution improvements and decelerating input cost inflation, GPK’s management felt confident raising the company’s EBITDA forecast. It is anticipated that the price/cost mix benefit will moderate beginning in 2Q23, but will still be positive for the remainder of the year. Based on the provided guidance and the current performance, I believe the majority of the realized price increases will positively impact the financial results of FY23. However, the extent of these price increases flowing into 2024 is expected to be limited. As a result, we might see growth slowdown if volume did not pick up fast enough to cushion the normalization impact post FY23.
Conclusion
In conclusion, GPK’s 1Q23 results exceeded expectations, showcasing strong execution and improved profitability. The company’s ability to navigate market volatility and sustain steady volumes is commendable. With favorable pricing dynamics and successful contract renegotiations, GPK is well-positioned to capitalize on the current market conditions. Its dominant market position and economies of scale provide a competitive advantage in the commodity industry. Considering the valuation (near all-time low), positive growth outlook for FY23, and potential for sustained profitability, I recommend a buy rating for GPK.
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