Graphic Packaging: Hard To Repeat 2022 Performance (NYSE:GPK)

Graphic Packaging Holding Firm (NYSE:GPK) is coming from a powerful 2022, but it surely stays to be seen if its development can proceed in 2023. The corporate may have a powerful client to extend enterprise volumes in a posh financial surroundings. The high-interest price surroundings has lowered the valuation multiples utilized to varied sectors of the economic system. A reduced money circulate mannequin estimates the inventory to be absolutely valued. A supplies sector a number of of 13x offers the inventory a 50% upside assuming the corporate can obtain its 2023 earnings estimate.

Sturdy 2022 development could also be difficult to repeat.

Graphic Packaging noticed good income development in 2022. Natural gross sales elevated by 3% in 2022 in comparison with 2021. The corporate expanded its margins in 2022 to 19.4%, a brand new file in comparison with the previous decade (Exhibit 1). The corporate has averaged a gross margin of 17.5% since 2013. The corporate’s efficiency in 2022 was so robust that it expanded gross margins every quarter from 17.4% in March to twenty.5% within the quarter ending December 2022 (Exhibit 2). The corporate’s working margin expanded to 12.4% within the December quarter in comparison with a mean of 9.3% since June 2020.

Exhibit 1:

These are wonderful revenue margins for the corporate. However, buyers might query the long-term sturdiness and sustainability of those margins. Buyers can assess the margin variability by taking a look at the usual deviation. Since 2013 the gross margins have had an ordinary deviation of 1.55%, a low variability (Exhibit 1). Equally, the corporate’s working margins have a low variability of 1.39%. However, the present annual gross and working margins are elevated, one normal deviation above the imply (Exhibit 2).

Exhibit 2:

These excessive margins is probably not sustainable, with its gross margins dropping nearer to its long-run common of 17.5% and its working margins reverting to its imply.

Graphic Packaging’s feeble aggressive moat

At its coronary heart, Graphic Packaging Holding Firm provides commodity packaging supplies. Any aggressive benefit the corporate might acquire by way of acquisitions and new and fashionable manufacturing services could also be sustainable within the quick time period. The economic system’s power may additionally drive demand for the corporate’s merchandise and thus might influence margins. Though the corporate thinks a recession might not have an effect on profitability of the corporate.

The corporate highlighted the truth that through the 2009 recession, its adjusted EBITDA improved by $81 million y/y to $ 556 million, a development of 14% y/y (Exhibit 3). However, its core folding carton quantity declined by 3.6% y/y. The corporate’s gross margins dropped in 2008 and 2009, probably displaying some influence as a result of recession (Exhibit 4). The corporate has diversified into important client staples industries resembling Meals & Beverage, which can present some safety in opposition to a requirement collapse throughout a downturn. However, the corporate might not escape decrease volumes and margins throughout a recession.

Exhibit 3:

Exhibit 4:

The corporate’s greatest short-term aggressive benefit could also be as a result of present high-interest price surroundings. The corporate has expanded and grown at low-interest charges through the previous decade. It’s difficult for rivals so as to add new manufacturing capability on this price surroundings. The banking disaster, triggered by the collapse of Silicon Valley Financial institution, might make banks bolster their steadiness sheet and liquidity. This disaster might make them considerably cautious of constructing new loans. It might turn out to be troublesome for any firm to fund manufacturing growth utilizing debt. Lengthy-term buyers want to think about the aggressive moat and the demand drivers and make investments at a valuation that will present some margin of security.

Free Money Stream, Debt, and Valuation

The corporate’s working money circulate margin suffered in 2017 and 2018. In 2017 the corporate funded its retirement obligations for its staff, which took a chew out of working money flows. In 2018, receivables jumped to $1158.1 million from $658.8 million in 2017. This enhance in receivables lowered money flows. Contemplating 2017 and 2018 as outliers and excluding them from our evaluation, the working money circulate margin jumps from a mean of seven.14% over the previous decade to 10.25%.

Based mostly on the diluted share rely of 309.5 million and a share value of $23.30, the free money circulate yield per share is 7.5% on the finish of 2022, an excellent yield. A reduced money circulate mannequin yields a per-share worth of $23.72 (Exhibit 5). This mannequin assumes income development of 4%, a free money circulate margin of 5%, and a reduction price of 8%. This 5% free money circulate margin is properly above the common of three.4% over the previous decade, excluding 2017 and 2018, when free money circulate was detrimental.

Exhibit 5:

The corporate’s present price of capital is properly beneath 8%, primarily pushed by the low-interest charges it pays on debt issued through the low-interest price surroundings of the previous decade. However, the fairness holders demand a lot larger returns, and the borrowing prices have elevated significantly for all firms, particularly these with excessive debt ranges, resembling Graphic Packaging Holding Firm. On the finish of December 2022, the corporate has whole debt of $5 billion and internet debt (after money) of $4.9 billion (Exhibit 6). Its debt-to-EBITDA ratio stands at 3.7x particularly provided that the corporate had a powerful 2022 and generated excessive working revenue and money flows (Exhibit 7). Any weak spot within the enterprise would solely drive the debt ratios larger, justifying the speculative ranking by the ranking companies.

Exhibit 6:

Exhibit 7:

A debt-to-EBITDA ratio of 2x or beneath could be cheap for the corporate. Sooner or later, even a decrease debt would imply elevated curiosity expense. Buyers might have to concentrate to the continuing CapEx necessities since CapEx reduces free money circulate and might restrict the quantity the corporate can use to pay down its debt. The corporate has spent a mean of 6.7% (with an ordinary deviation of two.1%) of its income on CapEx over the previous decade (Exhibit 8).

Exhibit 8:

Given present charges and the corporate’s indebtedness, it might be too optimistic to imagine an 8% low cost price. However, even with a positive 8% low cost price, the per-share worth is about the place the inventory is priced immediately. Moody’s and S&P have given the corporate’s debt a speculative ranking, with Moody’s giving it a Ba1 and S&P giving it a BB+. In accordance with S&P, this BB+ ranking signifies the corporate’s debt is much less weak within the close to time period however faces ongoing uncertainties to hostile enterprise, monetary, and financial situations.

The corporate has a ahead GAAP PE of 9.2x, in comparison with the sector median of 13x and the corporate’s five-year common ahead GAAP PE of 16.9x. However, it might be unreasonable to count on Graphic Packaging Holding Firm to commerce at 16.9x on this financial surroundings. The Vanguard Supplies ETF (VAW) trades at a PE of 13.5x and a price-to-book ratio of two.8x. A 13x ahead PE would put the inventory at $35.75 based mostly on the 2023 EPS estimate of $2.75. Based mostly on the sector PE the inventory could also be undervalued.

Graphic Packaging Holding Firm loved a powerful 2022, however a recession might take maintain within the U.S. in 2023, impacting volumes, margins, and money flows. Given the demographic headwinds, the U.S. might have entered a decade of sluggish financial development with or with out a recession. The economic system might should get used to larger rates of interest and bouts of excessive inflation. Historic valuation metrics might not apply to the corporate any longer. The corporate operates in a commodity market with no aggressive moat. Buyers ought to be opportunistic in shopping for Graphic Packaging if the market’s volatility takes the inventory beneath $20.