Graphic Packaging Holding Co
NYSE:GPK
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Graphic Packaging Holding Co
Earnings Call Analysis
Q3-2024 Analysis
Graphic Packaging Holding Co
Graphic Packaging recorded third-quarter sales of $2.2 billion, reflecting resilient operations amidst challenging market conditions. Adjusted EBITDA was strong at $433 million, resulting in an adjusted EPS of $0.64. After a muted start to the year, there was a slight uptick in volume growth at 1%. Nonetheless, prices dipped by 2%, paralleling past quarters. The company maintained an impressive adjusted EBITDA margin of 19.5%, showcasing its robust business model.
The company is making significant capital investments, particularly in its Waco, Texas recycled paperboard facility, which is set to become operational by late 2025. This facility is crucial as it enhances their ability to meet North American demand for high-quality coated recycled paperboard. In addition, the recent commissioning of advanced printing technology at their Poznan facility in Poland is expected to strengthen their position in the European health and beauty market.
Graphic Packaging's focus on sustainability is highlighted through a virtual power purchase agreement aimed at reducing greenhouse gas emissions. The company is committed to a 50.4% reduction by 2032, which will result in approximately 70% of its electric consumption in Europe being renewable. This aligns with the growing demand for eco-friendly packaging solutions, making the company a preferred partner for consumers and retailers alike.
Despite achieving some volume recovery, the company has faced headwinds from destocking in retail and inflation pressures affecting consumer spending. The sales outlook for the fourth quarter is modest, with management expecting volume growth of 1% to 2%. The company experienced an $8 million positive impact from new acquisitions but faced a negative influence from weather-related power disruptions, which reduced adjusted EBITDA by $25 million.
Looking toward the remainder of 2024, Graphic Packaging expects full-year adjusted EBITDA to be between $1.68 billion and $1.73 billion, with adjusted EPS projected to range from $2.49 to $2.61. The anticipated downward revision in growth projections is reflective of lower-than-expected volumes in the second half of the year, down from a previously expected 3% to 4% growth. The company plans to pull forward maintenance work due to identified needs at its facilities, albeit this is not expected to substantially impact overall performance.
For 2025, Graphic Packaging aims for low single-digit sales growth, mid-single-digit growth in adjusted EBITDA, and high single-digit growth in adjusted EPS. The expected decline in capital expenditures post the Waco project will allow the company to redirect cash flow towards shareholder returns and further investments in innovation. This year is viewed as a pivotal point for cash generation expansion, ideally positioning them for the future growth trajectory.
Graphic Packaging has demonstrated resilience despite a challenging economic landscape, maintaining strong margins and positive volume growth signals. The strategic investments in innovation and sustainability, coupled with a solid financial performance, indicate a promising outlook for the company as it navigates current market volatility while planning for sustained growth in the future.
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Good day, everyone, and welcome to the Graphic Packaging Third Quarter 2024 Earnings Call. [Operator Instructions]
It is now my pleasure to turn the floor over to your host, Melanie Skijus. Ma'am, the floor is yours.
Good morning, and welcome to Graphic Packaging Holding Company's Third Quarter 2024 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 third 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 turn the call over to Mike.
Thank you, Melanie. Good morning, everyone, and thank you for joining our call today. Graphic Packaging is a global leader in sustainable consumer packaging with a portfolio constructed to deliver consistency and growth across a wide range of economic conditions.
Considering the uneven market conditions we have experienced in 2023 and 2024, we are indeed delivering solid results. In the third quarter, Graphic Packaging sales were $2.2 billion. Adjusted EBITDA was $433 million and adjusted EPS was $0.64. We saw clear but muted pivot to volume growth, up 1% during the third quarter after Europe's return to growth last quarter. Price was down 2%, relatively the same as last quarter. The company's adjusted EBITDA margin, despite the modest volume growth and some weather and power disruptions, was a very solid 19.5%, in line with our expectations. That speaks to the strength of the business we have built. In a challenging environment, we are delivering strong and consistent margins you should expect from a consumer packaging leader.
Turning to Slide 3. Waco, Texas recycled paperboard manufacturing facility investment remains on track for the fourth quarter and 2025 startup. We have recently begun the hiring process and made our first hires. The pool of applicants we are seeing is excellent as expected. An attractive labor pool is one of the key reasons the company selected Waco for this important strategic investment. Once Waco is up and running, we will be able to service the entire North American market with the highest quality coated recycled paperboard from 2 locations: In Michigan and Texas, which will further expand the company's long-term competitive advantage in both cost and quality.
During the quarter, we also made a number of packaging facility investments, and I'd like to highlight one in particular at our Poznan packaging facility in Poland. We recently completed the commissioning of Heidelberg XL106 for us with 10 colors, double [ varnish ] and other color at the end of the line and a cold foil unit. This state-of-the-art equipment is designed for high value, high complexity printing and significantly enhances our position in the European health and beauty market. Poznan is an excellent facility with a very strong team and an ideal location for this kind of investment. This new press not only strengthens the company's product offerings, but also increases our manufacturing flexibility, both of which are especially important to the health and beauty customers.
You may have seen our August announcement of a virtual power purchase agreement with the Zelestra, who will build 2 new solar power generating plants in Spain. The agreement is a key component of the company's plan to reduce Scope 1 and Scope 2 greenhouse gas emissions by 50.4% by 2032 and will take the company's purchased renewable electricity equivalent in Europe to approximately 70%. Reducing the company's carbon footprint is central to our mission as a leader in sustainable consumer packaging and part of what makes us the supplier of choice to leading consumer product companies, retailers and restaurants.
After the divestiture of the Augusta, Georgia bleached paperboard manufacturing facility in May, consumer packaging makes up approximately 95% of our sales with the sale of paperboard representing just 5%. As we have discussed in the past, the paperboard and paperboard packaging industry has changed dramatically, both in structure and competitor strategies. As a result, market movements related to the sale and pricing of paperboard have become far more challenging for third parties to assess. And so perhaps not surprisingly, their results are increasingly inconsistent with what we see in the market.
As we have previously disclosed, we are actively working to transition all Graphic Packaging customer contracts to more transparent and more accurate price change in each mechanisms. Beginning in the first quarter of 2025, we will no longer enter into new open market paperboard sales contracts that include third party price change mechanisms. This move with paperboard sales is a small but important piece of our ongoing transition.
Turning to the company's packaging results. As I noted, we saw a pivot to positive volume growth. Beverage and foodservice results were, again, solid, and we saw year-over-year improvement in food, household and health and beauty. While we had expected somewhat stronger volumes overall, we are pleased to see improvement across a large number of product categories and geographies. Mass retail and superstores continue to gain share in the grocery category, and that includes both private label and branded products. We are participating in this shift with a number of recent innovation wins in private label and mass retail, particularly with new multipacks and our proprietary Boardio paperboard canister solutions.
Innovation sales growth in the third quarter was $54 million, in line with our expectations, and we remain on track to deliver $200 million for the full year. These results are impressive and speak to the high priority customers put on moving to better, more sustainable packaging solutions. That is especially true in Europe where regulations are creating some urgency for new solutions, but also in North America, where the consumer-driven push for more sustainable packaging remains strong.
Slide 4 is a reminder of just how broad the company's portfolio really is and why we are able to generate solid results even in challenging market conditions. There's a very good chance that you've held at least one of our products in your hands in the last 24 hours.
Now let's look at our sales in more detail on Slide 5. We saw overall packaging sales improve after 2 quarters of weakness. As you can see, we saw improvement in food, household and health and beauty, and continued solid performance in beverage in the consumers markets. While we and many of our customers had expected even stronger volume improvement, that pivot back to positive volume growth is certainly encouraging.
Food markets, which represent approximately 40% of total sales saw improvement across a number of categories. Performance has been uneven and impacted by promotional activity, which was much stronger in some categories than in others.
Prepared food continues to do well with fewer people working from home, but consumers are choosing less expensive options. Frozen prepared meals, for example, remained weak, but frozen entrees are seeing growth amongst value-conscious consumers who might otherwise have grafted [indiscernible] quick service restaurants.
Refrigerated categories, including protein, were mostly softer, higher prices for both beef and chicken are driving consumers to look for cheaper options.
Private label has been making inroads in bakery where overall volumes remain relatively flat. And while high cocoa prices have dampened demand for confectionery in Europe, candy and gum held up better in the U.S. as an affordable indulgence. Savory snacks and other discretionary food market have been weaker.
In the beverage market, you've heard producers reporting uneven results, and we see that in our volumes. In beer, multipack volumes are down more than single-serve volumes. But in soft drinks, we are outperforming the market. These results reflect innovation wins, particularly in Europe, where new regulations are phasing out [ plastic spring carriers ] and [indiscernible]. We are also seeing pockets of strength in the U.S. in nonalcoholic beverage categories.
Promotional volumes increased in our foodservice business, and you have all heard in some of the biggest quick service restaurants that they plan to extend third quarter promotions through the fourth quarter. Whether increased promotional activity will help restore sustainable volume growth remains an open question so far, but we are working closely with our customers to find the right solutions for their strategies.
Beyond promotional activity, our foodservice customers are very focused on reducing or eliminating plastic both in Europe and in the U.S. We have a range of development programs underway with a number of foodservice customers, and we will be highlighting one recent innovation success in just a moment.
Household products results improved in the third quarter, the stronger results in tissue, pet care and food storage. Investors often ask, are there gaps you would like to fill in your portfolio? And the answer broadly is that our portfolio as a whole has very few significant gaps. But in household products, which is an exceptionally broad market, we have some very strong positions, but also plenty of categories where we have substantial room to grow here in North America and in Europe.
And finally, health and beauty continues to improve slowly. This is mainly a European business for us, and there, health care volumes remain relatively weak, while beauty has shown more improvement. Recently, we have seen many of the big cosmetic and personal care companies making a push for volumes with some success. We see a very attractive growth opportunity in these businesses in North America with our PaceSetter Rainier 100% recycled paperboard, which performs as well as the more expensive bleached paperboard.
But big packaging change decisions take time, and even more so in markets with very demanding prints and performance requirements like health care and cosmetics. We've been very encouraged by the feedback we are getting from customers who are testing the Rainier paperboard and expect to see solid growth in the years ahead.
If you will turn with me to Slide 6, you will see what typical seasonality looks like on the left. And while 2024 has been anything but typical in many respects, these quarterly patterns have held up reasonably well. During the third quarter, food was up sequentially and beverage was solid, but aggregate packaging sales were pretty flat sequentially. Monthly patterns have shown quite a bit more variation this year than we normally see. July, for example, is usually the weakest month of the third quarter, but this year was actually the strongest, as you know, to August, but September was unusually quiet.
We saw a return to positive growth in the third quarter as we had expected, with Europe continuing to improve after turning positive last quarter. The overall volume recovery remains quite gradual, however, even when we consider the relatively easier comps to the second half of 2023.
The timing of promotional activity may explain some of the variations from normal patterns, and we are certainly seeing high levels of promotion across food and foodservice categories, but to stretch consumer is having an impact on overall demand. And so far, higher promotional activity does not appear to be translating into materially higher volumes. We saw continued strength in private label and mass retail. And overall, pricing was not very different from what we saw in the second quarter, down approximately 2% year-over-year.
Looking ahead to the fourth quarter, we expect to see continued improvement in volumes driven by ongoing promotional activity, the rollout of new products at more affordable price points and the continued growth in mass retail superstore volume. But as you've been hearing from our customers, the strength and timing of that recovery has become more difficult to estimate.
The shift from fall to winter means more indoor holiday entertainment, which tends to support strong demand in various food categories but also is generally good news for foodservice demand and especially in our product portfolio at coffee.
Consumers continue to feel the pinch of relatively high food prices and we are working closely with our customers to develop packaging solutions they need to deliver on their strategies to drive higher volumes. Demand for packaging that is more circular, more functional and more convenient has never been higher. And today's affordability challenges while creating some headwinds are also creating new opportunities for Graphic Packaging to partner with customers to develop new and better solutions.
Slide 7 outlines the company's 5 innovation platforms, and I'm happy to report that we are seeing a high level of customer engagement across all 5. Plastic substitution is one of the more common themes across many of our innovations and we are having outstanding commercially tested solutions for a wide range of new applications.
Turning to Slide 8. Last quarter, I highlighted the company's paper [indiscernible] technology, a major upgrade in the way prepared food is packaged with better product visibility and much less plastic. Today, I want to share a new foodservice innovation that was recently rolled out across the United States and Canada at McDonald's.
The McDonald's McFlurry is a soft-serve frozen dessert served in a cup with a choice of toppings. McDonald's wanted a more sustainable container for its North American markets with less plastic. Our development team worked closely with McDonald's and [ Hobby TMS ] on a packaging solution that reduces operational complexity and improves user experiences while at the same time providing a reduction in single-use plastic. The wider opening and open top design makes it easier for employees to fill and serve. They also improved the customer experience, making mixing easier. Plastic reduction is achieved with the replacement of the clear plastic lid with a built-in four-flap paperboard lid.
These innovations in McFlurry packaging are helping McDonald's achieve its sustainability goals while improving operational efficiencies and advancing consumer experiences, a true win for the brand and for the environment.
Along with the new McFlurry packaging, McDonald's announced the release of a smaller size, mini McFlurry. We are pleased to support our customer with this new offering as well.
Finally, I'll end where I usually do with Graphic Packaging's Vision 2030 summary on Slide 9. We are a global sustainable consumer packaging company built on a foundation of innovation, exceptional people and a commitment to protecting and preserving the planet. And we do that while delivering exceptional results for customers, shareholders and all of our stakeholders. We are making excellent progress towards all of our Vision 2030 goals, and I am incredibly proud of the results the team is delivering, particularly in these challenging markets.
Now let me turn it over to Steve for a review of the company's financials and operations. Steve?
Thank you, Mike. Turning to Slide 10. In the third quarter, we again executed very well, generating a solid 19.5% adjusted EBITDA margin despite volumes that fell below expectations. .
Full reported sales were down $133 million, a $109 million of that decline represented the impact of the Augusta divestiture and the dramatic reduction in our participation in open market bleached paperboard sales.
Volume mix in our packaging business was up 1%, while [indiscernible] below our expectations after an encouraging start in July. Price in the quarter was down 2%, similar to last quarter with the North American and international businesses experiencing similar outcomes.
Sales impact from other M&A and foreign exchange were a combined $11 million net positive in the quarter. There were 2 unexpected sources of pressure on our adjusted EBITDA results in the quarter. The first was the impact of weather and power disruptions that we disclosed mid-quarter, which reduced adjusted EBITDA by $25 million.
The second was softer September sales, which left volumes below our expectations. Even so, excluding the weather and power disruption impact, strong net performance fully offset the price and inflation headwinds we experienced during the quarter.
Adjusted EBITDA impact from other M&A, excluding Augusta and foreign exchange was an $8 million tailwind. The [ Bell ] acquisition was completed in September of 2023. And as such, this is the last quarter that Bell will be included at M&A. As a reminder, the [indiscernible] divestiture took place in November of 2023.
Net leverage at 3.1x is at an acceptable level. And the company's current average cost of debt is approximately 4.7%. We expect to end the year with net leverage below 3x.
Slide 11 puts the strength of the company's business model into perspective. In the past 7 quarters, we have experienced a negative impact of a broad-based customer and retailer destocking and of a consumer under pressure from inflation. You could see the impact on volumes on the left side of this page. On the right side, you see that despite those challenges, we have generated strong and consistent adjusted EBITDA margin performance.
Looking at 2024 year-to-date, despite the challenges of destocking and consumer affordability, sales in our packaging business excluding the Augusta sale are down just 3%, with volume down 1%, driven by the strength of our innovation and execution, and price down 2%. While below our targets, these results are a demonstration of the strength of the business model under less-than-ideal conditions.
Graphic Packaging's transformation was designed to deliver consistency across a wide range of market conditions. Prior to the business transformation, we could not have maintained this level of volume, price and margin stability. As volumes improve, we expect operational leverage to drive continued strong margins, significant cash generation and above cost of capital returns.
Turning to operations and capital investments on Slide 12. The company's paperboard manufacturing facilities ran well during the quarter despite the weather and power disruptions we experienced. We were fortunate to have no material impact from either Hurricane Helene or Milton. The company's global packaging operations also ran very well during the quarter.
As Mike noted, we continue to invest in the company's packaging facilities with press investments high on our list of priorities. These tend to be relatively modest projects with attractive financial returns that allowed the company to deliver better results for customers and shareholders.
The Waco investment is also progressing very well. Deliveries are on schedule and the decision earlier this year to accelerate equipment orders meant that we did not have much exposure to the [ port strikes, ] key equipment like head boxes, dryers, rolls, et cetera, are either already on site or already in the United States if they were coming from overseas.
At this point, structural steel for the machine [ haul ] is complete and preparation for major equipment installation is well underway. We have as many as 1,400 contractors on site and have begun the hiring process for a full-time team. We have, however, experienced some modest project cost inflation that we have not been able to offset elsewhere, and have made targeted modifications to the facility's front-end processes to drive additional cost and quality advantages. Together, these raised expected project cost by approximately $100 million to $1.1 billion. Process changes will yield upside beyond our original $160 million incremental EBITDA estimate, and we plan to provide further details on those changes and the expected benefits on our fourth quarter call in February.
Turning to Slide 13 in the outlook. As Mike noted earlier, we saw a pivot to volume growth in the third quarter, but the demand recovery remains more gradual than we had anticipated. We now expect volume growth in the second half, excluding the impact of the Augusta divestiture to be in the 1% to 2% range, down from 3% to 4%. That reflects the reality of what customers are seeing and expecting relative to where we were a few months ago. We are now expecting full year adjusted EBITDA in the $1.68 billion to $1.73 billion range and full year adjusted EPS in the $2.49 and $2.61 range.
In addition to previously disclosed weather and power disruptions, revised guidance reflects the impact of lower expected second half volume as well as the decision we made to pull forward maintenance work. During the annual maintenance outage at the [ West Monroe ] paperboard manufacturing facility earlier this year, we identified additional required maintenance and repair issues with a digester and related equipment. When we were able to secure the necessary specialized contractors, we elected to get those repairs done now given the near-term volume outlook rather than wait until 2025. The total impact on adjusted EBITDA was less than $20 million, all of which will be incurred in the fourth quarter. We expect full year adjusted EBITDA margin to be in the 19% to 19.5% range, a very good outcome considering the challenging volume environment.
Looking ahead to 2025, we expect financial performance to be consistent with the company's base financial model, low single-digit sales growth, mid-single-digit adjusted EBITDA growth and high single-digit adjusted EPS growth. As you have heard us say, 2024 represents peak CapEx. And with the increase in anticipated 2024 CapEx, we are now anticipating a decline in spending in 2025 of approximately $300 million.
Slide 14 summarizes the company's Vision 2030 base financial model and outlines our capital allocation priorities. Waco is the last major asset investment in our strategy to capture a unique and powerful long-term competitive advantage in the North American consumer packaging market. Once complete, the company's capital allocation priorities turn naturally to a more normal level of reinvestment, growing the dividend, opportunistic share repurchase and tuck-under M&A.
Turning to Slide 15. Over the next several years, we expect to generate substantially more cash than we require for reinvestment. 2025 will mark the beginning of a multiyear cash flow expansion cycle and we intend to deploy that incremental cash to generate returns to shareholders and strengthen Graphic Packaging's position as the world's leading sustainable consumer packaging company.
On Slide 17, you will find supplemental information that may be useful for modeling purposes.
That concludes our prepared remarks this morning. We will now turn the call back to the operator to begin Q&A. Operator?
[Operator Instructions] Your first question is coming from Matt Roberts from Raymond James.
My first question is on the sales guide into 2025. So clearly, exiting second half '24 lower, and you noted low single digits of, I believe it was, 2024 less $144 million from [ Augusta ] in the first few months there. So while early, maybe you could help me bridge that in terms of overall volume expectations by end market? Any change in timing on innovation, sales and in regard to the price change mechanisms you mentioned? Should we expect a price benefit from that in 2025? Or is that more of an evolution that will take time as contracts come up for renewal?
Matt, it's Steve. Why don't I start and then Mike can add some color there. I think just in terms of the leap-off point for next year in terms of the top line, I think Page 14 does a nice job of adjusting for the limited time we have Augusta in 2024, so about an $8.8 billion top line will be the starting point. And what we're indicating is that our innovation engine should continue to provide a couple of hundred basis points of growth next year. And overall, the market evolving this year being down a little bit at the market level that kind of evolving towards neutral or very modest growth. I mean that's kind of the enabler for low single-digit top line growth.
I'll let Mike talk about the mechanisms that we're putting in place. We're very excited about the new price change mechanisms that we're executing on in the open market and with customers. And so we'll talk about that probably a little bit separately. But that's the overall kind of enabler for low single-digit top line growth next year. Mike?
Matt, I think maybe just to expand a little bit on what Steve said. While it was below our expectations, the pivot to growth was important in the quarter. And so that gives us confidence in terms of the jump-off point as we head into 2025. That's consistent with what we've seen at least through the month of October here as we head into 2025 in the new year.
Steve covered the innovation, so I won't go into more detail on that. But in regards to the pricing mechanism, you have to remember that on the open market paperboard side, really only about 5% of what we do is selling paperboard to customers. So the vast majority flows through cartons and cups where we've been on a multiyear journey of modifying those proprietary customer relationships in terms of pricing that we have, moving away from third-party indexes. So this is really just an ongoing transition that we've been on over several years to move away from those types of mechanisms. And I wouldn't expect that to be a material impact in 2025, just given the small nature of what we sell on the open market, but it's an important step, and we believe over time, helps give our customers more confidence in their ability to predict their pricing because they want that to be fair. They wanted to be transparent and they don't want to be surprised. And all those things are really what we're aiming to do with our customers.
Okay. Yes, Mike, Steve. And for my second question, looking out into 2025 and even maybe beyond there, how is the competitive landscape shifting or maybe even bifurcating between your bleached and unbleached paperboard products versus recycled products? How does that impact the price ROIC or margin in recycled versus other parts of the business? And if one side is generally more favorable than the other, are there alternatives that you would consider that further accelerate that shift towards recycled products?
Matt, I appreciate the question. Look, in terms of how we're positioning the company, you saw us make a big move with the sale of the Augusta mill. And again, the Augusta mill was a largely open market seller of coated bleached paperboard where we just didn't have a competitive advantage, it was [indiscernible] or distinct from other market participants.
So what we did, and as we talked about this, and I think there's still maybe some maybe some confusion around why it was so important, but it's incredibly strategic for us to have the Texarkana mill, that's largely integrated into our own operations. The vast majority of what we make in Texarkana is cupstock. We don't sell cupstock in a material way to the open market. We're selling [ cups. ] And we had the ability to make our own coated bleach where we need to. And so that really fits us really well and allows us not to have to participate in the open market side of the bleached paperboard market, which is the most fragmented and quite frankly, where the biggest challenges are in the market.
Certainly, if that market gets messy, we get some secondary knock-on benefit, but we don't have the type of exposure we used to have when we had the Augusta mill. We've really focused our investments back in where we can make exceptional returns for our shareholders on the grades that we choose to make, and that being coated unbleached paperboard as well as coated recycled paperboard.
Both of those grades we're the low-cost producer in North America. We generate excellent returns on those. And of course, as you know, we've been making significant investments into both of those systems, with the biggest being the new paperboard manufacturing facilities we've invested in, in both Michigan and Texas. One in Texas will come to life next year this time in the fourth quarter as we've committed to. And we expect to see some real growth opportunities for us to be able to win with the high-quality and low-cost position that we have.
Steve, maybe you can talk a little bit about the arbitrage on margins?
Yes. The only thing I'd add to that, Matt, is that when you look at coated unbleached, our unbleached participation, our coated recycled board participation, you've got our facilities there incredibly well capitalized and are actually positioned to support the packaging growth algorithm and that couple of hundred basis points of growth year after year. So where we choose to make paperboard, it's competitively advantaged and supports our growth as a consumer packaging business. And I think that's really the critical imperative. It's obviously very constructive from a competitive dynamic, and our margin profile there allow us to generate the above cost of capital returns that you've seen as pivot to and that we can continue to exercise on with incredible margin stability.
And that really, as you're seeing this year, in a pretty tough volume environment, margin stability in that 19% to 20% range, that really speaks to the competitive advantage of choosing to make paperboard where we're competitively well positioned to make the packaging.
Again, we'll be down, Steve, to 5 paperboard manufacturing facilities when we're done with this capital expenditure that we're making in Waco. And as you stated, all these are incredibly well capitalized and low cost paperboard manufacturing facility. So we think we're uniquely positioned, Matt, to win in the marketplace based on that.
Your next question is coming from Lars Kjellberg from Stifel. .
Just going to start with a short-term question. Your third quarter volumes came in below your expectations. So can you provide any color where that happened in geography-wise in end markets? And also, you called out continued growth in Q4. With the slowdown you called out in September, specifically, I think you mentioned that October was looking better. But what is happening in that market? What happened in September and then that recovery you're now seeing in October, I guess, what is driving that in end markets and geographies, please?
Yes. Lars, I'll take the first part of it, and Steve can add on anything that I missed. I think -- and Steve talked about this in his prepared comments. We started off the quarter very strong in July. August was pretty average and September was a little bit more muted. And when we kind of look at what fourth quarter looks like, we see it kind of being more around that 1% to 2% volumetric number based on what our customers are telling us now.
Now based on what we heard coming out of the second quarter, we were hearing from them that we would see stronger sales. That was their plan. They were initiating a number of promotions, things like that. And you have to remember, the vast majority of everything we do is customized printed packaging. So when they say that they're going to grow, they have to have us ready to make those packages. So we have to be prepared to be able to do that, or they have supply chain issues, out-of-stock issues, which cost them money with retailers. So we have to take that stuff very seriously. And as the third quarter played out, we didn't see as much of that as we were expecting or what they were expecting, you've seen a number of our customers have already released and they talked about some of these muted volumes.
So that's really the dynamic that drives it. We've got to be very tight with them, very closely coordinated with them to make sure that we're there when they need us. But when they fall short, it does impact us, and that's what hurt us in the third quarter.
And Lars, the only thing I'd add is geographically, we continue to see positive volume growth from Europe driven by our innovation activities there. Last quarter, our European and international operations were 50% of our innovation. This quarter was 40%, so still very substantial. And then we saw the improvement for the quarter. But as we've shared, I mean, sometimes it's a bit uneven. We've got pockets of good, strong, steady growth and then expectations will be said by customers and they don't necessarily see as much sell-through. But the actual pivot, as Mike said, to real volume growth in the quarter was important, below what we expected, but it's a positive and gives us some of that confidence heading into Q4 and then, of course, heading into the 2025.
Sure. And my follow-up question was actually related to sustainable packaging. You seem to have better visibility in that business. You delivered in line with what you had called out in spite of slower overall market. Again, highlighting that importance of that business for you, right? And you're recurrently talking about this as [indiscernible] something that repeat itself over the years ahead. So what gives you the confidence that should be a continued growth driver for you? What are you seeing in terms of innovation that you can talk to and/or increased adoption of your solutions down the line that would kind of give this benefit for the years ahead?
Lars, I'll take that, and Steve, you can jump in here if I miss anything. But I mean, if you take a step back and take a look at really this year, we're telling you we're going to be on track to make the 2%, which would be about $200 million of commercial sales through our innovation pipelines. And you go back 3 additional years, so 4 years now, we'll hit that mark. So that informs some level of confidence that the overall algorithm we've got out there is generating those kind of sales and consistency as we kind of look at the market and the opportunities we have in front of us.
In the deck, you saw a profile of kind of what we call a modified TAM. Remember the way we define TAM, [indiscernible] something that we already have sold or we're very close to selling. And that number has grown quite a bit. It's now almost $15 billion in total. So the market, the addressable market is we look at it with the products that we make and manufacture has gotten bigger. And that creates more opportunities for us, Lars, to continue to drive those kind of projects.
When I look at the funnel that I see in front of us and the interest from customers, it's high. Now I will say it's a bit lumpy from time to time. You have a product like the one we profiled here in the third quarter like the McFlurry. And that was one that came in, and in about a 6-month period of time, they knew what they wanted, they wanted to get in the marketplace, and it flowed through really fast and did a national launch, both in the U.S. and Canada.
On the other side, we've talked to you about Chick-fil-A in the past, and Chick-fil-A was an important test market that we did. We tested a double wall cup and a premium single-wall cup in multiple stores, multiple geographies that took over a year to do all the testing. In the end, they decided to take a premium single-wall up, and that was part of that test that we will supply. And ultimately, that was the decision they made for a rationale that is the customer's choice. So you can kind of see a compare and contrast, some kind of move through kind of quickly, some take a little bit more time, but they're really important. And even on the double wall cup, we've got a couple of customers now on the high end, iced coffee and milks and shakes that are actually going to launch, too, in particular. These are smaller customers, but they're important. We'll get it out in the marketplace. It's a technology that works really, really good.
It actually kind of reminded me a little bit of our [indiscernible] product that is a replacement in the European market where you're at for polyester bottles. We invented that in 2009. It was one of the greatest things I've ever seen. And we went 12 years and didn't sell it to anybody. And now we've actually got a number of sales that are going into the European market because the market changed and consumers with customers have to move out of high [indiscernible] rates.
And so you've got to have a steady stream of these things and be working on them all the time. but it's not linear in terms of how it plays out. But we've got enough bets that it gives me confidence.
Your next question is coming from Lewis Merrick from BNP Paribas.
Mike, Steve, as you've talked about before, you're currently transitioning our customers away from contracts priced based on [indiscernible] indexes. Point index is more representative of your cost base. Can you just give us an update roughly how much of your packaging business is operated on these new contract structures? And I've got a follow-up after that, if that's okay.
Yes. Lewis, it's Steve. I'll kind of back up a little bit. As Mike mentioned, we've really been in a multiyear journey of making sure that our contractual relationships with our customers are representative of the value of the packaging. So we're well along in making sure that we're pricing our products or the inherent value of the package. And keep in mind that every year, we're renegotiating with a good 25% to 35% of our customers. So we have to re-earn their business very routinely. And so that's a great opportunity for us to always make sure that we're pricing our products, packages for their value. .
About half of our business is already in a spot where it's attached to either more cost-based models or more annual type models. And what's next for us is the development of a new index, that's actually an index that's attached to known commodities that correlate nicely with our cost structure. We've got a couple of large negotiations underway right now with some very large global customers, where we're bringing that into this multiyear relationship.
So as we've talked before, it will be a journey. But we don't want to imply that it's a new journey. We've been well along in value-based pricing for multiple years. This is kind of the next step. As Mike mentioned, transitioning our open-market paperboard, that remaining 5%, moving that away from a third-party index is just all part of a multiyear initiative that is well on. But the current large-scale customer negotiations where we're bringing this to life will be a nice proof point that our interest and our customers' interest in the consistency and transparency of an alternative price change mechanism is high.
I think maybe just one thing to expound upon a little bit. And Lewis, Steve did a nice job outlining that. What he outlined was the price change mechanism. Remember, we have to earn this business with tenders and RFPs. So we know we're market competitive at that point in time. All we're talking about is the movement in between the period of time between the tender.
Perfect. And just on the technicals. On the change to leverage guidance. We were previously 2.7x, I believe, last quarter on the guidance, now less than 3x. I understand the CapEx guidance has been raised and EBITDA guidance adjusted somewhat. But just taking into account those effects, it seems like there's possibly some other items contributing that must be working capital. Is there anything to call out on that movement?
There's nothing to call out. I think it's really the combination of a midpoint guide that was -- went from $1.78 billion in the low [ 1.7s ] and an extra $100 million on the CapEx. So sub-3 is, we think, a good place to end. And obviously, we're going to keep the balance sheet in a good spot, but nothing unusual to call out.
Your next question is coming from Arun Viswanathan from RBC Capital Markets.
So I guess my first question would be just a clarification. So I think on one of the guidance slides, you note that the updated range for '24 includes the contribution from Augusta. Then on the subsequent slide, it says $1.7 billion. So when you say that the base is $1.7 billion for '24, does that include $40 million for EBITDA contribution from Augusta in '24? And so the real base should be something like [ $1.66 billion? ] And I guess the reason I'm asking is because you have called out mid-single-digit growth for '25 on EBITDA. And so if we apply it to the $1.66 billion, maybe we would only get to say, $1.7 billion or $1.72 billion. And if we applied it to the $1.7 billion, we get more into the $1.75 billion or $1.76 billion range. Could you just clarify that for us?
Yes. I'd be glad to, Arun. I think on Page 13, the guide for 2024, of course, includes everything that was in 2024, which would have a little bit of Augusta in the first 4 months of the year. Page 14 is a bit intentional. It is where is the leap-off point as you do to what the work you just did. So [ 8.8 ] would exclude a little bit of Augusta from this year, the $1.7 billion is roughly where we see the business kind of functioning as the leap off point for next year that will be low $1.7 billion tier in the guide. There's a little bit of Augusta. We've got a couple of headwinds this year that obviously, we grew [indiscernible] here for you. But generally speaking, for modeling purposes right around $1.7 billion or very slightly below it. would be the leap-off point for the math that you're doing, not back to $1.66 billion.
Okay. And then another question I had was just on the pricing outlook. We've noticed, obviously, that there's been some increase in exports out of Europe into North America from some of the Northern European players because of weakness in demand in Europe. I think we've seen some exports from Asia into Europe of paperboard. And then we've also seen Suzano, who is making some strong remarks about entering foodservice and cupstock in a big way.
So does that kind of worry you on the pricing outlook? I mean we did see down [ 30 ] in CUK 1 month or 2 months ago, and I understand that the indices may not necessarily be getting the same read on the market dynamics as you are from your customers. But just wanted to get your thoughts on that, especially in light of the fact that we are seeing some inflation that may push some of your CapEx requirements a little bit higher. But just wanted to see what your thoughts are on some of these differences in supply/demand that we're seeing.
Yes, Arun. I'll take a stab at this. I'm going to unpack some numbers here because you've asked kind of a broad range of questions there. And I think it's important we use some of the data to help us inform our decision.
Before I start, I will say that I think this is the 35th call I've done as CEO, and this question around imports has come up on almost every single call. And yet imports into the U.S. right now in total across all 3 grades are just a few percent. But if you kind of look at the [ census ] data, which is the best data we have to look at that, and you unpack it a bit because paperboard tends to be kind of a catch-all for a number of grades. The Scandinavian imports are the ones that we would look at as the most relevant for us. And when you kind of drop through that and look at coated unbleached paperboard, it's a 2.5 million ton market. There's been 140,000 tons of imports. So call that 5% roughly, pretty small.
You look at SBS, which is what FBB would go after. It's a 6 million ton market in the U.S. And in the case of imports, that's about 450,000 tons year-to-date. So again, about 7.5%. That's the most that's come into that. And again, I already talked about the fact that we divested our Augusta mill. So we're not really in the open market sale of bleached paperboard in a material way at all.
Then you've got recycled paperboard being about a 2.7 million ton market, with imports largely from Canada, I might add, being about 2%. So it's pretty small. You put that all together and you even look at the 2024 data and compare it to '23, it's down. So when you read some of these things, and it makes it sound like the numbers are increasing, but they're not based on the data that we've got. And also if you go back to '22, it's the same story, which is kind of the high watermark for imports into this market.
I'm not really surprised, and I'll tell you why. Because when you look at the fiber cost in Scandinavia, as we talked about on our last call, they've gone up dramatically. Containers are 4x more expensive to get from Europe to the United States because of the imbalance of trade. So the cost profile that they have to do to get that material here is very, very high.
Now in the short term, could someone make a short-term strategy because they're dealing with a tough market? Of course. And could that have implications for us in the short term? Absolutely. But based on a 3-decade experience in this market. I will tell you that over time, low-cost wins, high-cost loses over the medium to long term. And you wind up seeing a number of these facilities that will ultimately go away because that's just basic economics. And so could there be some short-term implications? Maybe. But for us, it's not something we spend a huge amount of time on because it's not a big part of the market.
There's a couple of other changes that have happened really over that period of time, too. You look at what's transpired in the North American market on paperboard supply. If you go back 10 years ago, there were 18 suppliers of paperboard in the U.S. Now, that number -- there's only 10. Of that 18 only 4 continue to exist. Some have new leadership. There's some new entrants, as you talked about [indiscernible] here. They'll all have to decide how they want to compete in this market.
But there's 2 other things that have transpired here that also impact that as well. One is the consolidation of converting. 10 years ago, we estimate that open market was probably almost 70% of that of the market, meaning that the paperboard was sold into the open market and nonintegrated suppliers bought it. Now we would estimate that, that 10% goes through integrated packaging companies like Graphic Packaging. We've been a big part of that consolidation that's happened. So you got to figure out where you're going to sell those tons, if you're a non-integrated supplier. And in the case of Graphic, as we've talked about, we're going to run our own stuff and we drove our integration rates up.
At the same time, you see the third-party indexes talking more and more to brokers and getting their information from paperboard brokers. And broker strategies and their motivations could be completely different than ours for a variety of reasons. They do what they do, and we do what we do. But that's who they're talking to, and there's a disconnect in our opinion in terms of what that looks like so much so, 2 years ago, we quit selling all our off-grade in seconds to brokers. We actually take that material and pulp it up, put it back into our process. It does not go to the open market anymore.
That's part of what Steve talked about when he said we've got a little bit more expenditure in Waco. We actually found some ways to even be more efficient in processing those second materials so that they'll never go to the market. We're going to use that as good, high-quality fiber that ultimately benefits our customers.
So you got to have different converting strategies and different ways you think about it, but all this kind of comes together. The moves we're making with pricing, the moves we're making around the tuck-under acquisitions that we've done and the investments we make back into our paperboard manufacturing facilities where we see we can get an outsized return. I know that's a long answer to your question, but it's the nuance, and I wanted to make sure that I kind of hit it all. And I'll take any follow-ups you may have on that.
No, that's awesome. I really appreciate that. The only quick follow-up I had was just on the CapEx. Looks like you're still guiding to $800 million to $1 billion in '26. Do you still see that as likely, especially in light of some inflation on that CapEx? Or still pretty confident in that?
No, Arun, it's Steve. No, our confidence in the free cash flow inflection from today's limited free chas flow given the Waco investment next year step down to $800 million. And then in 2026, a clear step down to sub-5% to 5% of sales, which would be sub-$500 million is quite high. And so our confidence in that $800 million to $1 billion of cash flow in 2026, it's absolute. We're reviewing our long-range capital plans literally again this week. As you know, we always have those in place. We know the projects. We know the step down. We know where this is going, [ $1.1 billion, $800 million, sub-500. ] And that's the path to the cash flow generation that we're committed to. We know it by project. So I think that confidence in the multiyear free cash flow step up is exceptionally high, and we know the projects and we know what we'll execute on.
These things can move around the edges with growth projects or what have you. But overall, we know where and how we'll invest our CapEx to support the low and mid high single-digit growth agenda for the financial model for the company.
Your next question is coming from Ghansham Panjabi from Baird.
Yes. I guess going back to Slide 11, where you have packaging volumes and the adjusted EBITDA margins, and very nice charts by the way. What is the base case for 2025 as it relates to market conditions, as it relates to your low single-digit sales guidance? Is it just basically your innovation that's going to drive that and you're assuming the market is kind of flat? What's the base case at this point?
Yes. No, you said it well, Ghansham. I think the base case would be a couple of hundred basis points from our innovation engine and a flat to very modestly up consumer given that this year, if you kind of step back from it with innovation up 2% and overall, our volumes are going to be 0 to minus 1. You've got a consumer that's kind of in the minus 2%, minus 3% range. So the base case for us were low single-digit top line is a couple of hundred basis points of innovation, 0 to 1 on the rest, which gives us low single-digit top line volume growth, which is what we were trying to convey on the left side of Page 11. And thanks for recognizing the chart. It is a good add.
Okay. Terrific. And then as it relates to the promotional activity and that's been throw around. And we are seeing signs of that as consumers in foodservice and to some extent, food, et cetera. Is that dynamic, is it building on itself? Has it sort of plateaued? What are your customers thinking as it relates to going into next year? Because obviously, the consumer affordability component on that chart is not going to change near term, right?
It's a really great question, Ghansham. I mean we're trying to figure that out, too. I'll give you a few examples. Like on the foodservice side, these well-chronicled value meals that have been out there. We haven't seen an overall lift. We've seen mix changes. So what they're promoting sells quite well and that means something else doesn't sell quite as well.
We see that, too, on the branded side, where we're seeing promotions on some of the categories that maybe are a little bit down like serial case bars, some refrigerated products. But what we'll see is that one of our branded customers will promote and the other won't. Meaning there will be a shift to, obviously, where the promotion is and maybe the other one doesn't sell as well. But the overall category doesn't really change too much in terms of the numbers that are out there.
So it is the right question. I wish I had a better answer for you today. That's just what we're seeing right now. What I feel good about is the inflection of growth that we've seen to this 1%. And if we can keep that market relatively stable like that and use the innovation, which we've got a high degree of confidence on, our ability to drive low single-digit revenue numbers into 2025 is strong.
Your next question is coming from George Staphos from Bank of America.
The question I had related to the last one. Is there a way, Mike, that you can -- obviously, you're very, very integrated with your customers and that's the lifeline and where you get your innovation from. But if your customers are still perhaps not pricing promoting where they need to, is there information you can relate to them and that you could get from leveraging further downstream, talking to retailers, getting their suggestions back, not only on packaging, the price points on promotion? How do you manage that?
And the related question there, if we think about pricing. You talked a lot about what you're doing as you're navigating your model to being more of a consumer packaging commercial model. A lot of the other consumer packaging companies over the years have moved their terms to adjust for where their customers take at the level that they indicated. And if they don't, building that into some additional pricing or volume in subsequent periods. How are you managing that in terms of your journey in terms of your contracts?
Yes, George. So you can appreciate that our large CPGs are pretty tied into the retailers that kind of market their materials and sell their materials. We are as well. Some of those retailers are customers of ours in terms of store brand items and private label items that we make for them, too.
So within the confines of what's appropriate, we try to move any trends that we can to help our customers win in the marketplace. That's a big part of our innovation design. A big part of the focused marketing activities that we have here at Graphic Packaging and a service we really try to provide our customers. Are they quite capable marketeers, as you can imagine? No. But there's always room for challenging existing norms and ideas, and that's really what we're trying to do.
In regards to the pricing part of your question, yes, I think what you're referencing, and it's true for us, this is a high fixed cost business. So if the volume goes down, those costs are under absorbed. So I'm not going to get into individual pricing mechanisms, but you're right. That is a factor we consider and have in these proprietary relationships we have with our customers around making sure that we're getting a fair deal as are they. The other part of that pulls through, too. If their volumes are up quite dramatically, then they should expect more favorable offering from us. And those are the things, when I talk about transparency and value and fairness, that our customers are really looking for.
Mike, if I could, as we look to next year, you've got the digester reversal, that's '25, you have the power outage issue from the third quarter, that's '25. Those are bridge items. If you hold pricing constant with where it is today, would pricing be a net positive or negative? And are there any other things that we should be sort of building in for our preliminary analysis for '25?
George, it's Steve. Just briefly, overall, right now, all the pricing flow through in the next year on kind of a mark-to-market basis is pretty neutral and traditional commodity inflation, pretty neutral, and labor and benefits inflation probably look similar to past practices just as you're thinking through those models. So much of the improvement for us will come from earning on positive volume growth in our traditional strong commitment to driving productivity every year that offsets other inflationary items. So pricing and commodity inflation in traditional terms are both pretty neutral right now.
Thank you. That concludes our Q&A session. I will now hand the conference back to Mike Doss for closing remarks. Please go ahead.
Thank you, operator. and thank you, everyone, for joining us on our call today. 2024 is a challenging year for consumer products companies and for quick service restaurants. But despite these headwinds, Graphic Packaging is delivering solid results. I'm very proud of our team, excited about our innovation pipeline and optimistic about our outlook. Thank you, and have a great day.
Thank you, everyone. This concludes today's event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.