Important Disclosures: Certain funds and accounts managed by us and our affiliates are currently long BERY.  We may buy and/or sell shares of BERY in the future for the funds and accounts managed by us without notice, and we are under no obligation or agreement to take, or not take, any action or restrict our actions in any manner.  This is not a recommendation to buy or sell shares.  Our views are subject to change without notice and we may trade in any manner, whether consistent or inconsistent with this investment thesis.  The information below is from public sources.  We have not independently verified this information and we make no representations as to the accuracy or correctness of any such information.  We undertake no obligation to update any information below.

Berry Plastics was written up in July 2015 by nantembo629.  Since then, the stock is up 9.0% while, based on my estimates, the company will generate 2016 free cash flow per share that is 25% higher than nantembo629’s forecast.  I believe Berry Plastics is an even more attractive long investment today based on a stronger overall growth profile and cheaper free cash flow valuation as a result of the Avintiv transaction. 

First I’ll provide a snapshot of the pro forma company.  As Berry’s stand-alone business has been examined in previous posts, I’ll then provide an overview of Avintiv’s business lines.  Afterward I’ll address risks and concerns other investors, with whom I’ve spoken, have raised about the stock.  I’ll conclude with a discussion on my pro forma free cash flow assumptions and the stock’s current valuation. 

Snapshot of Pro Forma Company as of Jan 2016:

-                 Revenue: $7.2 bn ($5.1 bn from Berry and $2.1 bn from Avintiv)

-                 Adj. EBITDA: $1.18 bn ($830 mm from Berry and $350 mm from Avintiv, including synergies)

-                 Sales Breakdown by Geography: North America (81% of sales), South America (6%), EMEA (9%), Asia Pacific (4%)

-                 FY 2016 Free Cash Flow Guidance of $475 mm, or $3.80 per share

-                 Net Debt / 2016e EBITDA: 5.0x 

Overview of Avintiv

Formerly PGI Specialty Materials, Avintiv is the largest manufacturer of non-woven specialty materials in the world.  Non-wovens are fabric-like materials that are used in disposable diapers, feminine hygiene products, adult incontinence products, fabric softening dryer sheets, disinfectant wipes, surgical gowns, medical face masks, house wrap, industrial cleaning wipes and many other products.  Despite being the global leader, Avintiv is still a small part of a very fragmented market.  The non-woven industry is an estimated $30 bn+ in annual sales, and Avintiv generated $2.1 bn of sales in 2014.  Primary competitors include Freudenberg Performance Materials (private), Kimberly Clark, Dupont, Ahlstrom, Fitesa (private), and John Manville (Berkshire Hathaway subsidiary). 

Here is a breakdown of Avintiv by geography:

-                 North America (51% of 2014 revenue)

o   Five manufacturing facilities in the US, one in Canada and one in Mexico

o   Primary Products:

§  Personal care: baby diapers, feminine hygiene products, fabric-softening dryer sheets

§  Infection prevention: surgical gowns/drapes, masks, household cleaning wipes

§  Other: pool and spa filtration materials, protective house wrap

-                 South America (16% of revenue). 

o   Two manufacturing facilities in Brazil, one in Argentina, one in Colombia

o   Primary Products:

§  Baby diapers, feminine hygiene products

·         Based on 2013 volume figures (most recent I could find), Avintiv had a 59% market share in Brazil with its next closest competitor at 22%.  Baby Diaper penetration in Brazil grew from 35% in 2005 to 57% in 2013 and continues to grow.  In Latin America (excluding Mexico), Avintiv commanded a 60% market share.  Latin America is the most consolidated market in the world.

§  Specialty Agriculture and Industrial customers (erosion control, separation, drainage for management of irrigation water in agriculture applications). 

-                 Europe, Middle East, India (23% of revenue) 

o   Two manufacturing facilities in UK, two in France, one in Germany, Italy, Spain and Netherlands; as well as India JV w/ one manufacturing facility in India

o   Primary Products:

§  Hygiene: baby diapers, adult incontinence products

§  Healthcare: surgical drapes, blood filtration, face masks

§  Industrial cable wrap

§  Geosynthetics for civil engineering, landscape and military use (large tarp mats seen on highways, railroads, airports, landfills, tunnels, dams, etc.) via proprietary S-tex spunmelt and hydroentanglement technology

-                 Asia (10% of revenue) 

o   Two manufacturing facilities in China

o   Primary Products:

§  Hygiene: baby diapers, adult incontinence products

2014 Revenue by Product Line:

-                 Hygiene (diapers, adult incontinence, feminine care): 45% of sales

-                 Healthcare (medical gowns and drapes, surgical masks, wound care): 12% of sales

-                 Wipes (Personal care, industrial, infection prevention): 13% of sales

-                 Technical Specialties (filtration units in pools, hospitals; and fiber-reinforced plastics in furniture and bedding): 14% of sales

-                 Building & Construction (Building wraps, geosynthetics, agricultural products): 16% of sales

Addressing Some Risks and Concerns:

In July 2015, Berry Plastics agreed to buy Avintiv from Blackstone Group in a $2.45 bn transaction, financed with debt.  The deal was met with much skepticism, and Berry’s stock traded down below $30 from the mid-$30s over the following weeks.  Below I discuss some risks and concerns:

Concern #1: 30% of the pro forma business is generated in cyclical end markets.

I believe the way some investors have derived this 30% figure is by adding up any segment of the company’s business that is not related to Consumer packaging, hygiene and healthcare and calling it hyper-cyclical.  My sense is that part of this may be related to how the company describes certain of its more cyclical end markets.  For example, within their “Engineered Materials” business, the company includes revenue from sales of institutional garbage bags that are used for safe disposal of food at restaurants and infectious waste at hospitals.  Stretch film used to wrap vegetables at grocery stores and industrial-strength duct tapes for plumbing and HVAC applications are also included within this segment.  I estimate that actual cyclical end markets are closer to 10-15% of total EBITDA.  While the company did admit some softness in their industrial and construction-related business lines, performance in the near-term does not sound overly worrisome as management also gave some positive commentary around the Engineered Materials business in their 1Q 2016 Call:

“Our Engineered Materials business is off to a stronger start than we initially predicted. Primary drivers for growth have been favorable raw material costs, increased activity in the industrial markets, and share gains in core film products.

We are also experiencing positive sales momentum from our new high-end stretch film and recent product launches,

such as IRONFORCE branded tapes, which are exclusively available at The Home Depot.” – CEO, Jon Rich 2/10/16

Concern #2: The Company has unsustainably benefitted from low oil prices.

Resin comprises of 50% of cost of goods sold, with roughly a 60% polypropylene and 40% polyethylene split.  75% of total resin pounds sold have contractual pass-through clauses with an income statement lag of about a month.  One of the primary, long-lasting benefits that we can appreciate as equity holders of a post-LBO situation, is that the private equity holders went to great lengths to seek to lock in resin price pass-through provisions into many of the company’s contracts.  Per the 4Q15 call, management stated that 2015 EBITDA only benefitted by $5 mm from a lag benefit from lower resin costs.

As one of the largest procurers of polypropylene and polyethylene in the world, the new Berry Plastics should be able to leverage its purchasing power and compete more effectively.  The availability of low-cost feedstock in North America could present a tremendous opportunity for Berry to negotiate favorable, long-term off-take agreements with suppliers. 

Concern #3: Leverage is too high

This risk, in conjunction with concerns #1 and #2, seem to be the primary knocks on the stock, based on what I’ve heard.  However, if you believe, as I do, that there are adequate responses to concerns #1 and #2, then concern #3 becomes less of a worry.  This is a business that had been levered at 7-8x when it was LBO’d by Apollo.  I believe the stability of the free cash flow in this business entitles it to carry higher leverage at 5x EBITDA.  Importantly, the company has pushed out any significant maturities to 2020 and beyond and carries no financial covenants on its debt.  We project that the company could de-lever at least a half of a turn per year and get within their 3-4x target in about two years.

Concern #4: Blackstone has underinvested in Avintiv and starved them of capex.

While probably true to a certain extent, our calculations lead us to conclude that Berry’s management includes a “full” capex figure for Avintiv in its full year guidance.  Management maintains that maintenance capex is only $110 mm in 2016 vs. the $285 mm that is contemplated in the 2016 full year guidance.  This guidance assumes $80 mm of capex at Avintiv, which compares to $50 mm, $50 mm, and $80 mm of capex in 2014, 2013, and 2012, respectively.  The $80 mm figure approximates 3.8% of total sales, which is in line with one of the company’s “cleaner” publicly traded comps, Ahlstrom.

Free Cash Flow and Valuation

Management provided the following guidance for 2016 Free Cash Flow:

Assumptions:

-                 No change in resin costs

-                 Flat volumes

-                 Flat working capital

-                 Constant Currency Rates

I make the following adjustments to get to a “normalized” free cash flow figure:

-                 2016 EBITDA only includes $45 mm of the $60 mm of synergies anticipated from the Avintiv transaction

-                 Cash Taxes are lower than normal due to utilization of NOLs after remitting 85% of its NOLs to pre-IPO holders via the Tax Receivable Agreement.  The Company anticipates that it will utilize all of its NOLs under the TRA over the next two to four years, after which they will utilize $400 mm of federal NOLs from the Avintiv acquisition.  The result is that cash taxes will actually go down for a period after the NOLs under the TRA are depleted.  For purposes of valuation, we apply a full 35% tax rate.

-                 Restructuring charges will likely move towards zero, assuming no further acquisitions

Adjusting for all of these items, yields approximately $4.00 of “normalized” 2016 free cash flow and a NOL PV of $1.00 per share.  Based on this math, Berry is trading at 8.75x FCF @ a $36 stock price.  We estimate that FCF per share can grow 10% per year, assuming modest volume growth, returns on capex spent on productivity improvements and interest expense savings from debt reduction. 

Of course, there can be no assurance that our estimates or assumptions will be correct.  Any investment in BERY is subject to risks and uncertainties, including the risks identified above.