Graphic Packaging Holding Company

Moat: 2.5/5

Understandability: 2/5

Balance Sheet Health: 3.5/5

Graphic Packaging Holding Company is a global provider of paper-based packaging solutions, serving a wide range of consumer markets with an emphasis on providing sustainable and innovative packaging.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Graphic Packaging Holding Company (GPHC) is primarily engaged in providing paper-based packaging solutions.

  • Product Mix: Their portfolio includes a variety of packaging materials, from folding cartons to paperboard used in beverage, food, and other consumer goods packaging, and other types of paperboard used in converting operations.
  • Global Reach: GPHC operates on a global scale, with manufacturing facilities across the U.S., Europe, Asia, and other parts of the world. This geographic diversity helps the company serve its multinational clients.
  • Key Customer Industries: GPHC has a diversified client base that includes major players in the food, beverage, consumer goods, and pharmaceutical sectors.
  • Competitive Landscape: The packaging industry is a competitive landscape, with both large integrated companies and smaller, specialized players vying for market share.
  • Sustainability: A major trend is the increasing demand for sustainable packaging materials, driven by consumer preferences and environmental regulations. This trend favors paper-based packaging solutions, placing GPHC in an advantageous position. However, plastic packaging is trying to counter this by becoming more sustainable too.
  • Growth Markets: Emerging economies in Asia and Latin America offer opportunities for growth due to increasing populations and consumer spending.
  • Consolidation: The global packaging market is slowly consolidating, with mergers and acquisitions being relatively common, especially amongst smaller players.
  • Innovation: Constant innovation in packaging, materials, technologies, and production processes is required to maintain a competitive advantage.

Financial Analysis

Recent results show improving profitability and margins for GPHC, primarily due to higher sales volume and improving operating efficiencies.

  • Revenue:
    • FY22: $9.47B
    • FY21: $7.12B
    • Growth YoY: 32.9%
  • Operating Income:
    • FY22: $1.10B
    • FY21: $463M
    • Growth YoY: 137%
  • Net Income:
    • FY22: $335M
    • FY21: $37.7M
    • Growth YoY: 791%
  • EBITDA Margin:
    • 2022: 15.0%
    • 2021: 10.0%
  • Return on Invested Capital (ROIC):
    • ROIC has been volatile and has averaged around 10%, showing a somewhat cyclical pattern of business performance, mostly driven by industry wide factors.
  • Leverage: The company has taken on a relatively high level of debt for acquisitions. Their debt to equity ratio for 2022 was 1.04. GPHC’s debt includes various forms of financing including term loans, asset-backed securities, revolving credit facilities, and bonds. Credit ratings have ranged from BBB to Ba1 in the past few years, indicating the debt is at investment grade level but that there is risk.

  • GPHC has issued a mix of fixed and floating rate debt. As interest rates rise, the percentage of floating debt could put pressure on the balance sheet, though fixed-rate debt could also become a headwind. However, many of GPHC’s debt agreements have interest rate swaps or other hedges, that might alleviate the damage from rising interest rates.

    • Share repurchases: In the most recent quarters, the company has engaged in share buyback programs, reducing their shares outstanding and increasing shareholder value.
  • Share dilution: Employee stock compensation programs, while being necessary to retain key workers, also dilute shareholder ownership.
  • Net sales growth: Sales have grown a lot lately, because of increased demand and increased prices. Sales growth should slow down in the coming years due to economic uncertainty. Also, acquisitions in other geographical regions have contributed heavily to sales growth.

Moat Assessment: 2.5 / 5

GPHC has a moat due to its large scale and long term relationships with a stable customer base.

GPHC’s economic moat is considered narrow and mostly attributable to its size and scale advantage along with some network effects. Here’s a detailed breakdown:

  • Intangible assets: GPHC has a moderately strong brand recognition and reputation, particularly among its established clients. However, the paper and packaging industry is also very competitive with few brands standing above the rest. They have some patents on unique paper blends, but these aren’t very long lasting.
  • Switching Costs: Customer switching costs are moderate, as changing packaging vendors can disrupt supply chains and require validation of new packaging materials. The larger the customers, the higher the switching cost, as integrating with a new vendor will take a long time for them.
  • Network Effects: To a limited degree, GPHC does have network effects in specific markets. A robust and widespread distribution network creates a virtuous cycle, making it easier for GPHC to service more clients. Customers in turn value this strong network, as they know they will always get what they need, on time. However, a competitor can create their own network relatively easily, it would just take them a long time to do so.
  • Cost Advantages: As a large manufacturer, GPHC enjoys some economies of scale. They have facilities close to major consumer markets, which reduces their delivery costs and helps with customer satisfaction. They also have some manufacturing efficiencies, including specialized production technologies, that may reduce costs to a certain level. However, other companies can relatively easily copy these optimizations, so that limits GPHC’s edge, as a company with slightly better process, can come in at a slightly lower cost.

Given the above, GPHC does exhibit some moat characteristics, but these aren’t as strong as those of many other wide-moat companies. Thus a 2.5 rating seems appropriate.

Risks to Moat and Resilience

While GPHC has a narrow moat, various risks can erode that competitive advantage over time.

  • Raw Material Costs: Changes in the price of raw materials such as paper, wood, pulp, energy and chemicals can directly impact profitability.
  • Industry Consolidation: Mergers and acquisitions can shift competitive dynamics, potentially creating stronger competitors. GPHC needs to stay vigilant to stay at the top and avoid smaller companies to start taking their business.
  • Substitution Risk: If alternative packaging materials, such as sustainable plastics, become more viable or if new technologies decrease prices for different types of packaging material. For example, some big brand names have moved away from paper based packaging to other more sustainable alternatives.
  • Technological Disruption: Technological changes in packaging or production processes could disrupt GPHC’s existing business model. So, the company must invest in R&D to stay at the top. The main problem will be that innovations don’t typically last long and it can always be outdone by another competitor.
  • Customer Concentration: Although the customer base is quite diversified, GPHC still needs to maintain good relationships with large clients, as their business depends on it. If any major clients leave, it could cause a dent in revenues.
  • Financial Flexibility: GPHC’s substantial debt levels may limit its ability to withstand financial downturns or pursue growth opportunities that need extra investment. This is always a concern with highly leveraged companies, as high debt can reduce their growth potential in the long run.
  • Macroeconomic conditions: The company’s operations are highly correlated with the general macroeconomic climate, such as housing construction, that could have an impact on revenues.
  • Environmental regulation: The increase in environmental regulations and compliance requirements for manufacturing and paper products is increasing costs and adding operational challenges.

However, GPHC has shown itself to be resilient to these types of threats in the past, showing the ability to maintain a decent level of profitability even after experiencing downturns.

Understandability: 2 / 5

GPHC is difficult to understand because the company’s financials are quite complicated with acquisitions, asset writeoffs, restructuring charges, etc.

GPHC is a company with a lot of moving parts that are very hard to get a grasp of. Here’s a summary of factors that make it hard to fully understand:

  • Complex Financials: The many financial statements that are included with the reports are hard to understand for someone who isn’t an expert in accounting. There are tons of non-operating activities, acquisitions, and restructuring charges that are hard to analyze.
  • Diverse product offering: With such a wide variety of product offerings, it is tough to analyze the performance of the company on a granular level.
  • Geographical diversity: The company operates on a global scale, making it hard for investors to understand how GPHC operates in different regions of the world. Each of these has its unique set of risks and rewards, which require further analysis to understand.
  • Industry Complexity: The paper and packaging industry is large, complex and is heavily dependent on the global economy. It is also subject to the changing preferences of customers, environmental regulations, the need for innovation, and many other factors, that are hard to project accurately.
  • Acquisitions: A big portion of GPHC’s growth has come from acquisitions, and understanding each one of them and their performance has made things really hard.

Balance Sheet Health: 3.5 / 5

GPHC has a healthy balance sheet with good liquidity and reasonable debt.

  • Liquidity: GPHC has reasonably good liquidity to meet current obligations, with a cash balance of $622 million (as of Dec 2022), and a current ratio of 1.75.
  • Debt: The company has $4.6B of net debt, which is quite large. Given that the company’s total assets are $10.2B, this represents a debt-to-asset ratio of around 0.45 (45%), which is somewhat high, however GPHC’s debt is rated as investment grade, which reduces the risk of default substantially.
  • Equity: At the end of 2022, GPHC had around $5.9 billion in equity. Which gives a debt to equity ratio of 0.78, which is ok given that it is above the typical debt-to-equity ratio in the overall economy.
  • Cash Flow: The company has a positive and solid free cash flow generation, which provides flexibility for future operations and to deleverage their balance sheet in time.
  • Goodwill and Acquired Intangibles: Intangible assets make up a large portion of total assets at $4.1B, which adds complexity to valuations and the financial picture, as these items do not directly generate cash flows. There are also $2.6B of goodwill and this number should continue to decline, as goodwill is written off gradually over time.

Recent Concerns

  • Inflation and Supply chain Issues: Like most companies, the company has been affected by the global supply chain issues, the rising costs of raw materials, logistics and energy, all while having to deliver to customers on a reliable basis. Their operating expenses, especially for energy, have climbed significantly during 2022, but they have also increased their sales and prices, to offset that problem.
  • Merger with Smurfit Kappa: During this last year, GPHC has abandoned its merger with Smurfit Kappa Group because of unfavorable conditions in the stock market and the need for regulatory approval.
  • Acquisitions: Although acquisitions are a major part of GPHC’s growth strategy, there is increased risk of overpaying for these companies, that will lead to write-offs, which have affected GPHC’s balance sheet in the recent years.

Conclusion

GPHC, a global packaging giant, possesses a narrow economic moat due to its scale advantages and network effects, but the industry and its balance sheet carry several inherent risks and complexities, making a full analysis a tough task, although the current results are more and more promising. Therefore, GPHC is a somewhat less attractive investment for investors wanting to analyze companies through their financial statements.