Description

Berry Plastics is a long.  BERY is an attractive business generating significant cash flows (helped by the recent refinancing of 9.75% notes) that are currently being used to de-lever the balance sheet but will soon be utilized for share buybacks and/or tuck-in acquisitions.  We see the stock trading on a levered free cash flow yield of ~10% in 2016.  We think fears of packaged food volume declines are more than priced in and when looking a year or two out, we think the stock should trade closer to $45/share (~35% upside) based on 15x FCF multiple or 9x EBITDA.    

Berry Plastics is a leading manufacturer of plastic consumer packaging and engineered materials.  Approximately 55% of revenues are rigid packaging (drink cups, containers, bottles), 15% flexible packaging (personal care, films, coated & laminated packaging, etc.), and 30% engineered materials (tapes, food wrap, etc.).  The company holds #1 or #2 market positions in >75% of their sales.  The majority of sales are domestic, with +90% in North America.  The largest end market is food & beverage at ~40%, followed by industrial at ~20%, and the remainder being split between personal care, healthcare, household and retail.  Customer concentration is low, with the largest customer being ~3% of sales. 

In addition to the company’s core products, BERY has a history of innovation and new products, such as Versalite and NuSeal, hold significant potential.  Versalite is a fully recyclable insulated cup (as opposed to Styrofoam, which is not recyclable and paper cups, which are not insulated).  This is a large breakthrough and the company is in the process of signing contacts and ramping up production (Dunkin Donuts and 7-11 are currently using them with a large pick-up in orders expected soon).  It will take some time and contract wins before this represents a large portion of the company’s earnings but it clearly provides large optionality and an offset so weakness in other parts of the business.

The company’s largest raw materials are plastic resins (they are one of the largest global purchasers of polyolefin resins and are able to achieve scale purchasing savings) and they have contractual pass-through mechanisms on ~80% of their contracts.  The majority of these mechanisms are monthly or bi-monthly, with the remainder being quarterly.  Prior to the collapse in crude last year, resin price increases were somewhat of a headwind due to timing differences.  Part of the reason for the upside move in BERY in 2H14 was due to the fact that investors started to look at resin price decreases (due to oil move) as a tailwind.  While this should provide a tailwind over the next few quarters, on both an earnings and working capital basis, over the long-term this should normalize and is not a big driver.  

The plastic packaging market is very fragmented (although it is highly oligopolistic when it comes to specific products), and BERY has been an active acquirer executing 34 acquisitions over the past 24 years.  The company’s revenue CAGR since 2000 has been 23% and management estimates that ~4-5% of that has been organic.  The company has been a successful acquirer in the past (and we think this could be a big driver of growth going forward.

One of this biggest overhangs on the stock is the decline in packaged food volumes as consumers move towards more fresh food versus packaged.  Industry volumes have been down over the past couple of years.  BERY has been able to offset this volume decline with pricing, M&A and productivity enhancements.  New products that are being introduced, such as Versalite, should also help to offset this volume decline.  The company can also become more aggressive on the M&A side going forward as leverage moves to a more appropriate level

Valuation

While BERY does not look super cheap near-term on an EBITDA or EPS basis (~9x and ~17x 2016, respectively), we see it as incredibly cheap a couple of years out due to very high free cash flow generation.  In fact, we see the company generating ~$3.15/share in free cash flow in 2016 and ~$3.35/share in free cash flow in 2017.  Much of the company’s free cash flow generation in the next couple of years will be used to pay down debt and de-lever a balance sheet that currently sits at 4.4x Net Debt/EBITDA (versus over 7x leverage that was placed on the company in the 2006 buyout).  This leverage is probably keeping a good number of investors away for now.  However, we think the balance sheet leverage will move under 4x in the next 12 months (in-line with the company’s 2-4x target range) and that investors are underestimating both the quality and cash-generating ability of the business.  Placing a free cash flow multiple of 15x (6.7% fcf yield) on our estimate gets us to a valuation of ~$45/share or ~35% upside over the next 1-2 years. 

Major Risks

The main risks to the thesis include:

-          The balance sheet leverage (4.4x) is a risk and higher interest rates could hurt due to variable rate debt  

-          Volume growth has been tepid and this could lead to potential earnings misses if volumes do not pick up from here or they are not able to offset with new products and M&A.

-          The plastic container business has been relatively rational, in terms of pricing, but there is always the risk that a competitor may start pricing more aggressively in order to gain business (especially in light of recent slow demand growth trends).

-          The company has stated that it will look at more acquisitions, which will likely be small.  However, the risk would be that they decide to go ahead with a larger acquisition and overpay.

-          While most of the company’s products are used in relatively defensive industries (i.e. food packaging, etc.) there is a discretionary element that could be hit in a recession. 

Catalyst

- More Versalite order announements

- M&A and/or share buybacks as leverage continues to decline