Description
AETC is a leading North American developer and manufacturer of highly specialized oriented polypropylene ("OPP") films in North America used in candy wrappers, soda bottle labels and snack bags.
The Company generally sells its film products to converters, which are companies specializing in processes such as laminating multiple films or other materials together and printing text and graphics to form the final label or packaging material for end-users.
AETC recently completed the purchase of the assets of a private competitor in the OPP market. The purchase is instantly accretive, adding $20MM in sales and about $4MM to the bottom-line for FY01 and it increases AETC’s share of the market to approximately 40%.
The assets will basically be used as spare parts, the real acquisition was the customer list. Doing a deal like this back in FY99 AETC kept 90% of the customers and they expect the same from this purchase. The total purchase price of $23MM includes $8MM in inventories, thus they paid only .75 for each new dollar in sales.
The increased market share, coupled with weakening raw material costs for the foreseeable future, will give AETC increased pricing power. Nominal increases in industry wide OPP production need to support the 6% per year, clockwork-like growth of demand for OPP. Building a new line involves at least $50MM in investments and 2.5 year build time, thus AETC is in a good position to reap the benefits of this strengthening seller’s market. New competitors and additional production expansion seem unlikely.
Moody's anticipates that capital expenditures, absent further acquisitions, will likely be on par with recent historical spending in the near term while reducing over time as the company ramps additional capacity purchased in prior periods.
During the near to intermediate term, Moody's expects AET's revenues and margins will benefit from the recovery of the OPP films industry through higher average selling prices, volume gains, and cost savings.
Management has also demonstrated their competence by increasing quarter over quarter revenue inline with industry growth without resorting to channel stuffing. Accounts receivable has grown slower than sales, 5.4 vs. 6.1% for sales for Q201 over Q200. In addition the number two slot in the OPP production business is held by XOM, who combined with AETC produce approximately 50% of the OPP consumed in North America. The remaining 50% is divided up among eight other competitors. They have been competing and winning against XOM for quite some time.
AETC’s economies of scale have allowed them to increase gross margins from 14.5% in Q300 to 20% in Q201 and operating margins have quadrupled in the same time frame.
At a current price of $6.10 they are trading at .90x tangible book value and only .28x FY00 sales. Industry average is 3x sales. FY00 they lost (.10) per share but consensus estimates for FY01 are a profit of .08 per share with AETC providing guidance for FY02 of 1.50 per share. Based on that guidance ROA should be about double industry average and ROE about triple the average.
The past and current depressed valuations are overwhelming due to a covenant in their secured revolving debt that dictated that unless their $150MM in senior notes was refinanced by 11/01/01, the balance would become due. As of Q201 the balance was $61MM. This would have had a serious impact on the viability of the firm if they had to pay this in full.
However they are closing a $200MM 10 year note deal on 06/12/01, which will meet that covenant and reduce interest rate expense which currently stands at $5.5MM per quarter. JP Morgan and Merrill Lynch are managing the offering. It should be added that the purchase of this customer list was a significant factor given for the ability to quickly refinance.
Catalyst
Purchase of customer list that immediately accretes to earnings and refinancing of debt into long term notes.