BERRY GLOBAL GROUP INC BERY
November 20, 2020 - 12:01pm EST by
quads1025
2020 2021
Price: 55.15 EPS 4.85 5.88
Shares Out. (in M): 133 P/E 11.4 9.4
Market Cap (in $M): 7,300 P/FCF 7.7 7.7
Net Debt (in $M): 9,500 EBIT 1,366 1,398
TEV ($): 16,800 TEV/EBIT 12.3 12.0

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Description

 

EXECUTIVE SUMMARY

 

Berry Global Group, Inc. ("BERY") is a leading global supplier of a broad range of rigid, flexible and non-woven products used within consumer and industrial end markets.  The stock should be driven upward by two main factors.  First, the narrative around the stock should change.  Specifically, the market’s perception of BERY as a “value trap” due to its history of negative organic volume growth should change to “undervalued stock” given the Company just reported its third consecutive quarter of organic volume growth and guided for continued organic volume growth in 2021.  Second, the Company is focused on reducing its leverage, the high level of which has prevented many investors from engaging in the stock.  Management is guiding for the Company’s leverage to decline from 4.3x currently to 3.8-3.9x by the end of fiscal 2021 (September FY end).  A leverage level below 4.0x appears to be the point at which investors seek to reengage.  While these factors should drive the stock upwards, there are other potential positive catalysts as well, including the presence of a shareholder activist, dividend initiation, and S&P400 Index inclusion.

 

My price target for the stock is $75, up ~35% from current levels, and based on the Company trading at a very reasonable 9.0x EV / 2021E EBITDA, equating to a 10% FCF yield.  For reference, BERY’s closest comp is Amcor Plc (AMCR) which is currently trading at 12.4x EV / 2021E EBITDA.

 

 

 

COMPANY DESCRIPTION

 

BERY is a leading global supplier of a broad range of rigid, flexible and non-woven products used within consumer and industrial end markets.  The Company generates ~70% of revenues from stable, consumer-oriented end markets.  In 2019 (September FY end) sales by end market were: Home, Health & Personal Care – 30%, Food & Beverage – 34%, Specialties – 25%, and Distribution – 11%.  Sales by geography in 2019 were: North America – 51%, EMEA – 40%, Asia Pacific – 5%, and Other – 4%.  The Company is organized into four reporting segments:

  • Consumer Packaging International (36% of 2020 Revenues, 33% of 2020 EBITDA) – Manufactures bottles and canisters, containers, closures and dispensing systems, pharmaceutical packaging, and polythene films.
  • Consumer Packaging North America (24% of 2020 Revenues, 27% of 2020 EBITDA) – Manufactures containers and pails, polypropylene cups and lids, closures and overcaps, bottles and prescriptions vials, and tubes.
  • Engineered Materials (20% of 2020 Revenues, 20% of 2020 EBITDA) – Manufactures shrink films, converter films, institutional can liners, tape products, food and consumer films, retail bags, PVC films, and agricultural films.
  • Health, Hygiene & Specialties (20% of 2020 Revenues, 20% of 2020 EBITDA) – Manufactures health products, hygiene products, and specialties products.

 

 

 

INVESTMENT THESIS

 

BERY’s stock at current price levels is a compelling long investment opportunity for the following reasons:

  • Variant Perception of Forward Organic Volume Growth – The market’s perception of BERY as a “value trap” due to its history of reporting organic volume declines should change as the Company’s spending on volume growth initiatives continues to produce results.  Historically, BERY has grown through acquisitions.  Having now purchased the remaining few strategic assets of size over the past 4 years and the fact that as of January 2019 Apollo Global Management, Inc. (APO) is no longer present on BERY’s board which constrained certain spending, BERY has shifted its focus toward organic volume growth initiatives.  During 2020 the Company announced the construction, expansion, or start of five facilities or product lines to capture increased volume demand.  Further, BERY’s capital expenditures are expected to remain elevated as the Company pursues additional growth initiatives domestically and internationally.  As these capacity additions come on line and ramp production over 2021 and 2022, BERY’s organic volume growth should expand.  This should change investors’ perception of the Company and potentially eliminate its valuation multiple differential with its closest peer.
  • Leverage Reduction Leading to Increased Long-Only Ownership – Post the debt-financed acquisition of RPC Group PLC (“RPC”) for $6.5 billion (closed 7/1/19), BERY is focused on reducing its net leverage from 4.3x currently to a target of 3.8-3.9x by the end of FY 2021.  Hedge funds have a higher ownership of BERY’s stock as many long-only funds either avoid or are prohibited from buying the stock due to the Company’s leverage.  By reducing leverage to <4.0x, BERY’s stock should gain long-only sponsorship which in turn should increase the Company’s valuation multiple.
  • Shareholder Activism – On 2/23/20 Canyon Capital Advisors (“Canyon”), holding 7% of BERY’s stock, sent a letter (included as Appendix A) to BERY’s board urging them to undertake specific actions to generate shareholder value.  Management was already in process of focusing on the activist’s primary concerns, mainly improving organic volume growth and reducing leverage.  However, the presence of a shareholder activist now places that much more pressure and urgency by the CEO to address these concerns.
  • Attractive Valuation – At its current stock price, BERY is trading at 7.8x 2021E EBITDA, 9.6x 2021E EPS and at a 12.7% yield on 2021E FCF, based on internal estimates.  The stock is trading at a significant discount to its closest peer, Amcor PLC (AMCR), which is trading at 12.4x 2021E EBITDA and 16.7x 2021E EPS, based on consensus estimates.

 

GLOBAL PACKGING MARKET

BERY participates in the global packaging market which is not only growing but projected to grow at an increasing rate over the next five years.  Further, the Company produces both flexible and rigid plastic products, the fastest growing substrates in global packaging.

According to industry research group Smithers, global packaging demand reached $920 billion in 2019.  Asia is the largest market, accounting for ~41% of world packaging consumption.  North America accounts for ~23%, Western Europe accounts for ~20%, and the Rest of World accounts for 16% of global packaging consumption.  The industry has grown from $860 billion in 2014, representing a 5-year CAGR of 1.3%.  The industry is forecast to grow at a 2.8% CAGR from 2019 through 2024 to reach $1.05 trillion at the end of that timeframe.  Industry growth is projected to be driven by rising real incomes, population growth, rising urbanization and the further development of a retail infrastructure in the emerging and developing nations of Asia, Africa, the Middle East and Eastern Europe.

Industrial/Transportation is the largest end-use market for packaging and represents 43% of global consumption.  Food packaging accounts for 28% of global packaging demand.  Lifestyle factors are driving demand growth in food packaging, specifically consumer desire for health and wellness products, urbanization and busier lifestyles, and the continuing rise in single-parent households.  These trends create a growing demand for convenience products and the packaging for them.  Healthcare and Other represent the other main end-use markets for packaging.

In terms of substrates paperboard is the most used packaging material, accounting for 32% of global packaging consumption.  Flexible packaging accounts for 26%, rigid plastics accounts for 19%, metal accounts for 12%, glass accounts for 6% and Other accounts for 5%.  Despite environmental concerns, worldwide flexible plastic is set to grow at the fastest rate over 2019-2024, followed by rigid plastics and paperboard. The retail sector’s growing demand for extended shelf life for packaged product and consumer demand for convenience products are driving sales of barrier packaging films.  Plastic simply offers a lot of advantages in packaging over other substrates, including durability, protection/safety, design versatility, cost advantage, clarity, lighter weight leading to lower freight costs, and recyclability.

In terms of supply the North American plastic packaging market is highly fragmented.  For rigid plastics, the “Top 3” producers represent 27% of total supply, the next “#4-10” producers represent 24% of supply, while the next “#11-100” producers represent 49% of supply.  For flexible plastics, the “Top 3” producers represent 24% of total supply, the next “#4-10” producers represent 27% of supply, while the next “#11-100” producers represent 49% of supply.

 

COMPANY OVERVIEW

BERY sells its products to a diverse mix of leading multi-national, regional and local customers.  The Company services over 20,000 customers globally.  BERY’s top customer represents <5% of total revenues and the Company’s top 10 customers represent ~20% of total revenues.  Blue chip customers of BERY include: Walmart Inc. (WMT), The Proctor & Gamble Company (PG), McDonald’s Corporation (MCD), Kimberly-Clark Corporation (KMB), Danone (BN FP) and many others.

Below is a more detailed description of each of BERY’s reporting segments:

  • Consumer Packaging International – This segment is primarily composed of the international portion of RPC.  This segment’s product groups consist of the following:
    • Bottles and Canisters – Manufactures a collection of narrow neck blow molded and injection-stretch molded packaging solutions for consumer and industrial applications across personal care, beverage, food and non-food markets.
    • Containers – Manufactures injection molded and thermoformed pails, jars, and tubs across consumer and industrial packaging end markets.
    • Closures and Dispensing Systems – Manufactures a wide range of closures, dispensing systems and applications for a variety of end markets specializing in convenience, safety, security, and ecommerce formats.
    • Pharmaceutical Devices and Packaging – Manufactures inhalers and dose counters in addition to containers and closures for over-the-counter and prescription medicines.
    • Polythene Films – Manufactures polythene films for a diverse range of end markets, including agriculture and horticulture, construction, industrial, healthcare and waste services and food & non-food retail.
    • Recycling – Has the capabilities to recycle both rigid and flexible end of life materials from industrial and consumer sources with a wide range of re-use applications across packaging and non-packaging formats.
    • Technical Components – Manufactures complex high-precision molds and molded components including temporary waste storage solutions and products manufactured using rotational molding technology for materials handling and specialty vehicles markets.

This segment generates sales from the following end markets:  Food & Beverage – 38%, Home, Health & Personal Care – 25%, Specialties – 37%.  Revenues by geography are: EMEA – 79%, Asia Pacific – 11%, and Other – 10%.

  • Consumer Packaging North America – This segment is primarily composed of BERY’s legacy Consumer Packaging business and the US portion of RPC.  This segment’s product groups consist of the following:
    • Containers and Pails – Manufactures a collection of containers and pails for branded and private label customers.  These are offered in various styles with accompanying lids, bails and handles.  Containers are available decorated with in-mold-labeling, indirect flexographic print, digital printing, direct print, and other decoration technologies.
    • Foodservice – Manufactures lightweight polypropylene cups and lids for hot and cold beverages.  Utilizing thermoforming and injection-molding, this segment offers mono-material cup and lid packaging solutions for simplification in post-consumer collection and compatibility with recycling systems.  End markets include quick service restaurants, fast casual dining, food service delivery, convenience stores, stadiums and retail stores.
    • Closures and Overcaps – Manufactures child-resistant, continuous-thread, and tamper evident closures, as well as aerosol overcaps.  End markets include household chemical, healthcare, food and beverage, and personal care.
    • Bottles and Prescription Vials – Manufactures bottles and prescription vials utilizing widely recyclable materials which service various spirits, food and beverage, vitamin and nutritional, and personal care markets.
    • Tubes – Manufactures a complete line of extruded and laminate tubes in a wide variety of sizes and material blends including blends up to 70% post-consumer resin.  The majority of tubes are sold in the personal care market but some are sold in the pharmaceutical and household chemical markets.

 This segment generates sales from the following end markets:  Food & Beverage – 60%, Home, Health & Personal Care – 27%, Distribution – 7%, and Specialties – 6%.  Revenues by geography are: North America – 100%.

 

  • Engineered Materials – This segment’s product groups consist of the following:
    • Stretch and Shrink Films – Manufactures both hand and machine-wrap stretch films and custom shrink films, which are used to prepare products and packages for storage and shipping.
    • Converter Films – Manufactures sealant and barrier films for various flexible packaging converters companies
    • Institutional Can Liners – Manufactures trach-can liners and food bags for offices, restaurants, schools, hospitals, hotels, municipalities and manufacturing facilities.
    • Tape Products – Manufactures cloth and foil tape products.  Other tape products include high-quality, high performance liners of splicing and laminating tapes, flame-retardant tapes, flashing and seaming tapes, double-faced cloth, masking, mounting, OEM, and medical and specialty tapes.  Tape products are sold primarily through distributors and directly to end users for industrial, HVAC, building and construction, and retail market applications.
    • Food and Consumer Films – Manufactures printed film products for the fresh bakery, tortilla, deli, and frozen vegetable markets.  Also manufactures barrier films used for cereal, cookie, cracker and dry mix packages that are sold directly to food manufacturers.
    • Retail Bags – Manufactures a diversified portfolio of polyethylene-based film products to end users in the retail markets.  Products include drop cloths and retail trash bags.  These products are sold primarily through grocery stores, hardware stores, home improvement centers, paint stores, and mass merchandiser outlets.
    • PVC Films – Manufactures PVC films used primarily to wrap fresh meats, poultry, and produce for supermarket applications.  In addition, the segment offers a line of boxed products for food service and retail sales.  The segment services many of the leading supermarket chains, club stores, and wholesalers.
    • Agricultural Films – Manufactures agricultural films primarily used in the silage, green house and mulch applications.

This segment generates sales from the following end markets:  Distribution – 46%, Food & Beverage – 31%, and Specialties – 23%.  Revenues by geography are: North America – 98%, and Other – 2%.

  • Health, Hygiene & Specialties – This segment’s product groups consist of the following:
    • Health Products – Manufactures medical garment materials, surgical drapes, household cleaning wipes, and face masks.  Key end markets and application for these products is infection prevention.
    • Hygiene Products – Manufactures a collection of components for baby diapers, adult incontinence and other absorbent hygiene products, elastic films and laminates, and substrates for dryer sheets.  Primary end market is personal care.
    • Specialties Products – Manufactures a broad array of products and components for geosynthetics and filtration products servicing the specialty industry markets.

This segment generates sales from the following end markets:  Home, Health & Personal Care – 73% and Specialties – 27%.  Revenues by geography are: North America – 48%, EMEA – 24%, Asia Pacific – 10%, and Other – 18%.

 

RAW MATERIALS

BERY purchases ~7 billion pounds of plastic resin annually which represents ~50% of BERY’s Cost of Goods Sold.  Of the total resin purchased, approximately 55% is polyethylene and 40% is polypropylene.  Approximately 70% of resin pounds purchased have contractual price change “pass through” provisions with the end customer.

BERY highlights that their EBITDA margins have historically remained stable despite resin price volatility, as shown in the chart below:

 

 

ORGANIC VOLUME GROWTH

Despite generating revenue and EBITDA growth through acquisitions (46 since inception), BERY has drawn significant investor criticism for its history of reported organic volume declines, as shown in the chart below.  A surface level view of these declines could lead an investor to conclude that BERY is steadily losing business and is a “melting ice cube”.  However, there are two significant drivers of the declines that must be appreciated:

  • Product Rationalization and Supplier Diversification Post an Acquisition – BERY’s organic volume declines are partially a result of the Company’s historical growth through acquisition business model.  Specifically, BERY often acquires companies which have certain products or product lines with suboptimal margin and return characteristics.  Post-acquisition, BERY raises the prices of these products and is willing to walk away from the volume if the price increases are not accepted.  The elimination of less profitable products can be seen through analysis of BERY’s financials.  For instance, the margin of volume-driven EBITDA loss to volume-driven Revenue loss was 14.0% and 15.0% in 2017 and 2018, respectively.  This is in comparison to overall EBITDA margins of 18.7% and 17.5% in 2017 and 2018, respectively.  Accordingly, volume losses were lower margin in nature.  In addition, BERY also often loses volume post an acquisition if the end customer needs to diversify their supplier base.  For example, if the company BERY is acquiring plus legacy BERY together represents too large of a percentage of a customer’s supplier base, that customer most often redirects a portion of their volumes to another supplier to remain appropriately diversified.  For reference, below is a list of significant acquisitions BERY has completed in the last several years:
    • 06/02/14 – Rexam’s Healthcare Containers and Closures business for $135mm
    • 10/01/15 – AVINTIV Inc. for $2,450mm
    • 01/23/17 – AEP Industries Inc. for $746mm
    • 02/07/18 – Clopay Plastic Products Company for $475mm
    • 08/27/18 – Laddawn Inc. for $242mm
    • 07/01/19 – PRC Group PLC for $6.5 billion
  • Continuous Lightweighting – BERY’s volumes have also been historically reduced by ~1% per year through innovation and the continuous effort to further “lightweight” their products.  As an example, BERY management cited a drink cup the Company originally introduced a few years ago.  Since then, they have reduced the weight of the cup by 15% without diminishing quality or performance.

 

Although not recurring in nature, BERY also experienced significant organic volume loss in 2019 as the Company encountered complications in qualifying resin from a new supplier.  Those issues have now been resolved enabling BERY to start to recapture lost business.

 

 

A shift to consistent organic volume growth for BERY would be a major positive for the stock.  BERY demonstrated organic volume growth in 2Q20, 3Q20 and 4Q20 with only a portion of the growth due to Covid-related demand.  Management is guiding to 2% organic volume growth in 2021 as their organic growth initiatives progress.  Organic volume growth going forward should be supported by:

  • Limited Ability to Pursue Significant Acquisitions – For two main reasons BERY is unlikely to pursue any acquisitions, particularly of scale, for some time.  First, at 4.3x BERY’s leverage is too high to execute any significant acquisition without issuing a large amount of stock.  This would likely be prohibitively dilutive.  Second, BERY and its peers have already acquired almost every asset in their industry of reasonable size.  Accordingly, there are very few remaining assets the Company could pursue that would be large enough to have an impact on its financials.  Without completing acquisitions BERY will not experience the volume declines associated with them, as discussed above.
  • Noticeable Shift Toward Organic Volume Growth Initiatives – Over the past year management has announced numerous organic volume growth initiatives.  While some capacity expansions are associated with providing materials toward combatting Covid-19, most are not and are driven by growing market demand.  Specifically, on the 4Q20 earnings call BERY management emphasized that they are focusing on faster growth end markets, including (i) health and wellness (BERY has increased their sales to this end market from $500mm in 2015 to $1.0bn currently), (ii) food safety, and (iii) ecommerce.  Management also emphasized that they are increasing their presence in emerging markets, including Asia, South America, Mexico, Africa, and Eastern Europe (BERY has increased revenues in these faster growing regions from $100mm in 2013 to >$1.5bn currently).  Of note, the increase in growth spending can be seen in BERY’s upward shift in capital expenditures.  From 2016 through 2019 BERY invested an average of 4.3% of revenues on capital expenditures.  For 2020 management invested 5.0% of revenue and are guiding for a further increase to ~5.3% of revenues in 2021.  BERY’s organic growth initiatives include:

 

Date

Covid-19 Related?

Initiative

01/13/20

No

BERY announced that it had commercialized and started shipping product from its Reicofil R5 asset in Nanhai, China.  The facility manufactures high-loft, soft materials for the hygiene market.  “Demand for the new materials has been very strong and we look forward to working closely with our customers to help them win in this exciting and competitive marketplace,” said BERY’s CEO Tom Salmon.

01/15/20

No

BERY announced plans to expand its hygiene, healthcare, and specialty films platform in North America.  The Company’s investment addresses both extrusion and printing capabilities, in support of growing breathable film and sustainable product market demands in the North American region.  The investment will included added capacity for BERY’s proprietary Sof-Flex technology and the addition of flexographic printing equipment.  The expansion, totaling ~$20mm, will be operational in 2020 across BERY’s US network breathable film producing plants and represents the first of a three phase Sof-Flex film expansion plant to be completed by 2022.

03/04/20

No

BERY announced that to address rising demand it is investing ~$30mm to increase production capacity for ultra-high performance stretch films.  The investment is allocated for new lines and upgrades to existing assets in nine of the Company’s North American locations that currently manufacture stretch films.  The projects are set to begin immediately and are expected to be completed by April 2021.  Transcend and Stratos machine films, and Fortitude hand film are three products within BERY’s portfolio that provide what customers are seeking: palletization films that decrease breakage, damage and loss, while reducing wrapping cost and providing sustainable value.  Accelerated demand and growth is projected for these ultra-high performance products.

03/10/20

No

BERY announced the commercialization of its new Spinlace production line in Mooresville, NC.  A $50mm investment, the asset is running at full production rates, providing an incremental 17,000 metric tons of annual capacity in the market place.  The Spinlace asset is focused on various wipes applications serving the healthcare, hygiene, household cleaning, foodservice and industrial markets.

03/31/20

Yes

BERY announced an investment in an additional specialty meltblown asset to produce high-efficiency filtration media serving the EMEIA markets.  The investment is targeted to meet increased demand and customer growth and will be focused on premium applications, such as FFP2 (N95) and FFP3 (N99) for industrial face mask and cabin air filtration markets.  “As a market leader in the space, we had been planning to add more capacity after our latest investment in Asia came on line.  The opportunity to support the fight against Covid-19 accelerated our decision,” said Cedric Ballay EVP & GM for Europe in Healthy, Hygiene and Specialties for BERY.

04/16/20

Yes

BERY announced strategic initiatives to increase production of face mask materials.  BERY has expanded its proprietary Meltex platform to add meltblown capacity in Waynsboro, VA.  The line will make meltblown materials which will ultimately be used in surgical-grade face masks along with N95 and N99 respirators.  This added capacity will support the manufacturing of ~200mm face masks annually.

05/21/20

Yes

BERY announced further capital investment in its global meltblown fabric capacity for South America.  This investment further strengthens the Company’s global reach and position as the leading nonwovens manufacturer.  This line is BERY’s first meltblown asset, based on its Meltex technology, to be located in South America and continues to support the demand for health and wellness products.  The investment will bring more than 400 metric tons of Meltex meltblown nonwoven material to the region, which will enable production of more than 500mm surgical-grade masks per year.  The new asset will be operational in the March 2021 quarter and will focus on the production of materials for ASTM L2, L3, and N95 masks.

10/08/20

No

BERY announced that it is investing in a state-of-the-art Reicofil R5 asset to provide incremental capacity to serve the fast growing Asia healthcare markets.  The investment is targeted to meet forecasted market and customer growth and will be focused on high performance applications in the desired healthcare markets.  The new asset will be installed at BERY’s Nanhai, China, facility, which is strategically positioned to serve customers in the rapidly growth Southeast Asia region.  Current projections are for startup in the September quarter of 2022.

 

 

 

 

KEY FINANCIALS

    2014 2015 2016 2017 2018 2019 2020 2021 2021
Revenues                    
Consumer Packaging - International           $ 215 $ 1,229 $ 4,195 $ 4,237 $ 4,279
Consumer Packaging - North America           2,463 2,636 2,850 2,975 2,989
Engineered Materials           2,558 2,475 2,330 2,514 2,615
Health, Hygiene & Specialties           2,633 2,538 2,334 2,447 2,472
  Total   $ 4,958 $ 4,881 $ 6,489 $ 7,095 $ 7,869 $ 8,878 $ 11,709 $ 12,173 $ 12,355
                     
Revenue Growth, %                    
Consumer Packaging - International             471.6% 241.3% 1.0% 1.0%
Consumer Packaging - North America             7.0% 8.1% 4.4% 0.5%
Engineered Materials             (3.2%) (5.9%) 7.9% 4.0%
Health, Hygiene & Specialties             (3.6%) (8.0%) 4.9% 1.0%
  Total   N.A.   (1.6%) 32.9% 9.3% 10.9% 12.8% 31.9% 4.0% 1.5%
                     
EBITDA                    
Consumer Packaging - International           32 197 703 710 716
Consumer Packaging - North America           431 475 591 594 597
Engineered Materials           424 405 426 442 459
Health, Hygiene & Specialties           493 453 437 441 446
  Total   785 815 1,210 1,327 1,380 1,530 2,157 2,187 2,218
                     
EBITDA Margin, %                    
Consumer Packaging - International           14.9% 16.0% 16.8% 16.8% 16.7%
Consumer Packaging - North America           17.5% 18.0% 20.7% 20.0% 20.0%
Engineered Materials           16.6% 16.4% 18.3% 17.6% 17.6%
Health, Hygiene & Specialties           18.7% 17.8% 18.7% 18.0% 18.0%
  Total   15.8% 16.7% 18.6% 18.7% 17.5% 17.2% 18.4% 18.0% 18.0%
                     
Free Cash Flow                    
Free Cash Flow     $ 457 $ 569 $ 706 $ 668 $ 802 $ 947 $ 950 $ 1,020

 

EVENTS / CATALYSTS

  • 1Q21 Earnings – Estimated to be released 02/01/21.
  • Achieving Target Leverage – BERY management has stated repeatedly that the top priority for the Company’s FCF is debt reduction.  Recently, BERY has called the following bonds:
    • 5.500% 2nd Lien Bonds due 2022 – Full redemption of $150mm, effective July 2020
    • 6.000% 2nd Lien Bonds due 2022 – Full redemption of $200mm, effective October 2020
    • 5.125% 2nd Lien Bonds due 2023 – Partial redemption of $400mm, effective August and September 2020

Management has guided to reaching a leverage level of 3.8-3.9x by the end of FY 2021.  When the target is reached, interest in BERY’s stock, particularly by long-only funds, should increase significantly.  Of note, a conversation with a sell-side analyst indicated that when his firm hosted an NDR for BERY in August 2020, not a single long-only fund met with the Company, despite a full effort on the broker’s part.  Universally, the response the broker received from the long-only community was, “Reach out to me when BERY’s leverage is below 4.0x.

  • Potential S&P 400 Index Addition – BERY’s high level of leverage has apparently been a contributing factor in its lack of inclusion into the S&P 400 Index.  Achieving its target level of leverage could prompt inclusion into the index which would drive incremental demand for its shares.
  • Dividend Initiation – After achieving its targeted level of leverage, BERY may initiate a dividend.  BERY’s closest peer Amcor trades at a significant premium to BERY in part because it is supported by its current dividend yield of 4.0%.  With $875-975mm in FCF projected for 2021 and growing from there, BERY can easily afford to distribute ~$400mm in annual dividends while still having FCF remaining for further debt reduction.  At a 4% yield this would equate to a market capitalization of $10,000mm, >35% higher than BERY’s current market capitalization.

 

APPENDIX A: CANYON CAPITAL’S LETTER TO BERY’S BOARD

 

February 23, 2020

 

Via FedEx

 

Mr. Thomas E. Salmon

President and CEO

Berry Global, Inc.

101 Oakley Street

Evansville, Indiana 47710

 

Re:      Berry Global, Inc. Capital Allocation

 

Dear Mr. Salmon:

 

Canyon Capital Advisors LLC is the investment advisor to funds and accounts (together with Canyon Capital Advisors LLC, "Canyon") that beneficially own, in the aggregate, over 9 million shares, or almost 7.0% of the outstanding common stock of Berry Global, Inc. ("Berry" or the "Company").  After extensive study and analysis, we believe that Berry continues to be significantly undervalued and that there are readily available steps by which the Company can unlock significant value for shareholders.

Canyon has been an investor in the packaging industry for decades and has held Berry debt and equity for more than fifteen years.  We pride ourselves on being long-term oriented shareholders with supportive management relationships.  To that end, we appreciate the steps that Berry took following our prior correspondence to authorize a $500 million share repurchase program in August 2018 and to consummate the acquisition of RPC Group Plc ("RPC") in 2019.  We believe Berry has acquired the global scale and innovation expertise to lead the packaging industry into a sustainable future.  However, at this point more should be done to unlock value for shareholders.

As described below, Canyon believes that Berry should immediately take the following steps: (1) publicly announce that it has hired an investment bank or other financial advisor to develop a clear plan of action toward accelerated deleveraging; (2) commit to achieving an investment grade rating (and cease M&A activity other than deleveraging transactions); and (3) get in front of environmental, social and governance ("ESG") trends and correct market misperceptions about sustainability.

During the course of Berry's existence as a public company, valuation of the Company's stock has lagged that of peers due to persistent concerns by investors regarding organic volumes, and the stock has been acutely discounted when – as now – leverage is high.  In connection with the release of the Company's first quarter 2020 results and the accompanying earnings call, management's tone has been constructive on volumes, but Berry's stock has meaningfully lagged in 2020 YTD (down 6.8% vs. S&P up 3.3% and peer group(1) +0.6%) after significantly lagging in 2019 as well (flat vs. S&P up 29% and peer group +34%).  While we are encouraged by management's conviction to meet guidance for the fiscal quarters ended March and June 2020, the Company has missed expectations in the past and therefore has failed to give the market confidence in management or its historic levering M&A strategy.

However, we are confident management will deliver on volume growth in the Company's Health, Hygiene and Specialties division and its Engineered Materials division, as was done for the Consumer Products division after years of market concern about the division. As investors in Berry's capital structure for the past 15 years, we appreciate management's efforts to consistently grow margins and cash flow in the course of integrating new businesses, sometimes at the expense of volumes, as the Company eliminates lower margin operations and rationalizes SKUs.  We remain confident management will continue its past record of exceeding its cash flow targets, as it has done every year as a public company.

Strategies Should Focus on Deleveraging and Achieving an Investment Grade Rating

But given Berry's rapid growth through acquisition, we believe now is the time to optimize the portfolio of assets by monetizing non-core assets for accelerated deleveraging.  We also believe the private market for packaging assets has never been stronger, with EBITDA sale multiples well into the double digits as can be seen in the table below.  As such, we believe selling non-core assets would be both highly accretive and deleveraging for the Company. 

 

(1) Peer group refers to selected comparable packaging companies (Amcor, Aptar, Ball, Crown, Graphic Packaging, Sealed Air, Silgan Holdings, and Sonoco Products)

Berry's stock historically has traded at a discount during periods when it is excessively leveraged.  That is the case now, as the Company is operating with a debt/EBITDA ratio of 4.9x.  The chart below reflects the market's historical valuation of Berry since it went public and illustrates the Company's leverage over the same period.

 

 

 

A look at Berry's peer group also shows a high correlation between low leverage and stock price performance.  We recognize that the Company has had success in generating substantial free cash flow, which has created interest coverage of 4.8x. The last time Berry's leverage was at a level similar to what it is today was in 2016, at which point interest coverage was 4.4x. This would suggest that the Company is in a better position today to handle its financial leverage than it was in 2016, yet the market valuation of the Company today is lower. Berry is significantly undervalued, currently trading at 7.3x 2020 EBITDA and a 14.2% FCF yield while comparable plastic packaging companies trade at 9-12x and 5-6% FCF yields.  Berry's closest peer, Amcor, is particularly notable by contrast. The market is valuing it at a 4-5x EBITDA premium to Berry, largely on account of a less levered capital structure and capital allocation policy that allows it to pay a dividend and repurchase shares, all while sustainably reinvesting in its business.

The decline in Berry's stock price is concerning given the performance of the market as a whole, and more worrisome still when Berry is compared to its peer group.  Berry has provided a total shareholder return ("TSR") of -15.6% over the past year and -12.4% over the past three years.  Over those same periods respectively, Berry's peers group has averaged TSRs of +14.4% and +27.1% while the S&P has returned +19.9% and +41.1%. What is more, the Company's liquidity and the attractiveness of passively owning its stock have been impaired by the Company's not being included in the S&P 400 Index. In our view, the Company's investor relations group could be more proactive in this respect. Anecdotally, Canyon has spoken with large institutional investors in Berry's peer group who have commented that they would like to, but cannot, own Berry's stock with its current levels of leverage.

We believe that the Company's will be able to generate at least $800 million in free cash flow in 2020, but we think that accelerated deleveraging by making targeted divestitures of non-core assets is critical at this stage in order to improve TSR.  Berry's sale of the Seal for Life business provides a practical example of how the Company can divest.  Canyon believes the Company should immediately retain an investment bank or other financial advisor to evaluate and provide guidance with respect to divestitures and other possible means of accelerated deleveraging.

More Work Needs to be Done With Respect to ESG

Canyon also believes that Berry should get in front of ESG trends and correct market misperceptions about the sustainability of its products.  Berry is positioned extremely well in the growing conversation regarding ESG due to the Company's scale, R&D prowess and global partnership with CPG customers who are promising to use more recycled content.  The volume growth that the Company is poised to deliver should go a long way toward countering the notion that plastics are unpopular from a sustainability perspective, but more can be done to ensure that the right message is conveyed to the market on these issues.

Examples of companies that have determined to get ahead of ESG perceptions and market storylines regarding sustainability include Nestlé, which has committed to pay $2 billion to develop a market for food grade recycled resins, and Unilever, which transitioned to post-consumer resins for Helmann's Mayonnaise.  Berry itself has announced a collaboration with SABIC to drive the innovation and use of polyolefin resins made from chemical recycling, and an agreement with Georgia-Pacific Recycling to create a closed loop system to recover, segregate, and reprocess post-consumer resin. Each of those was a commendable step in shifting toward sustainable products.  However, more work on this score is needed.

Although the Company recently has been more vocal with respect to ESG issues, faulty market perceptions have proven difficult to alter.  It is readily apparent that the market has embraced the sustainability narrative as it relates to aluminum can makers, which are being valued well above historical average multiples.  We believe very strongly that Berry and the rest of the plastic packaging supply chain has an equally compelling sustainability story to tell and we think the Company's efforts to do so can be more focused. ESG ratings should be a high priority for investor relations and management, but the Company appears to be behind the rest of the market in this respect, which is disconcerting given significant investor scrutiny in this area. Management and IR need to address ESG ratings proactively, not reactively as has been the case.

We appreciate that sustainability is a complex issue, and the current market perception that one substrate is "more sustainable" than others is overly simplistic.  Misperceptions that should be corrected include those relating to the impact of carbon emissions, water and other natural resource usage, food production, food waste, and end of life treatment (e.g., recycling).  As the charts below reflect and the public should be made aware, plastic can mitigate food waste and compares favorably from an environmental perspective to other materials, and an improved recycling rate will make it clear that plastic must be part of the solution, not the problem.