|Shares Out. (in M):||133||P/E||0||0|
|Market Cap (in $M):||6,285||P/FCF||9.34||0|
|Net Debt (in $M):||5,337||EBIT||0||0|
Berry Global has been written up on VIC multiple times. We want to focus our thesis on a few differentiated viewpoints that form the core of our thesis.
Structural Advantages That Are Becoming More Pronounced
First Berry, we believe Berry Global is a better business than most people think. Yes, it is low growth. But, it generates great recurring revenue and stable margins. At the end of the day, Berry produces flexible and rigid containers/packaging for things such as yogurt containers, bottled water, shrink wraps for supermarket produces and meats, cereal bags, laundry detergent containers, printed flexible pouches for food packaging, shampoo bottles, drink cups, closures, pharmacy vials, jars, tubes, tapes, trash bags, diaper linings, adult incontinent products, etc. There are a few common misconceptions about this business. First, it is a commoditized business with little differentiation. Second, it is a low margin business. In reality, Berry typically competes against much smaller players with less resources and much less scale in purchasing. Berry generates EBITDA margins in the high teens and return on capital in the mid to high 20s (EBIT/(current asset + Net PP&E)).
There have been some unique structural changes to the business in the last decade that has made Berry a better business. The shale revolution in the US has made natural gas cheaper. This has made North American resin cheaper than elsewhere in the world. Hence a North American plastic converter like Berry with large scale has a cost advantage. How much advantage does Berry has? After the acquisition of RPC, Berry will be the second largest plastic converter in the world with roughly $13 billion of sales just a tad smaller than the combined Amcor/Bemis. This scale provides immense advantage in buying resin. We have learned during our scuttle butt calls to industry participants that there is in essence an industry list price that the smallest player pays. Berry pays a deep discount to this list price. We have heard that this discount could potentially be up to 10% of revenue in extreme case. However, we like to benchmark Berry against other sizable players and we believe that this discount can be anywhere from 2-5% of revenue versus someone who generates sales in the hundreds of millions range. Berry traditionally has been able to extract about 5% of revenue in savings from their acquisitions. A good chunk of it is through savings in resin purchases. Scales in purchasing of other materials and transportation are also important. The rest came from best practices in operations. Berry has built up its business through dozens of acquisitions and the “buy and integrate” play book is their bread and butter. So why do resin suppliers want to sell to Berry at a discount. With $13 billion of sales and anticipated resin purchases in excess of $5 billion, the resin producers wants Berry’s volume to absorb overhead and then squeeze smaller players for profit. This model is similar in industrial gases where a gas producer will sell at much lower prices to a steel mill to ensure that the overhead is absorbed and then extract their profits from incremental customers. This was exactly the synergy thesis for AEP Industries which was bought by Berry Global for $765 million representing a sales EBITDA multiple of roughly 7.5x. Upon integration, Berry increased AEP’s EBITDA to roughly $180mm reducing acquisition multiple to 4.3x. This is a bit of a cherry picked example. But Berry consistently demonstrates ability to take out cost in their acquisitions.
Due to the low natural gas prices, resin capacity has increased and the number of suppliers has gone from a handful to about a dozen. This is the opposite of what has happened to the airline industry. We have directly asked this question to the resin producer such as Dow and Lyondell at a materials conference and they in essence admitted that an expansion of resin producers coupled with a consolidating plastic converters will lead to lower margins for the resin producer over time. We believe that Berry will structurally take more margin over time as Berry gets larger and its suppliers become more fragmented. On the other hand, the customer side is getting more fragmented as well. Twitter, Instagram, and Facebook have lead to the emergence of a thousand brands. The old models of the big consumer product companies like Big Beer, Big Processes Food, etc who can utilized their large advertising dollars and create distance between them and the little guys are starting to fade and actually reverse. It is increasingly easier for smaller brands to win market share from the Krafts of the world. Hence, the bargaining power of the customers will likely go down overtime. From a structural and competitive perspective, we think that Berry will likely be more advantageous.
Owned Real Estate
While we have heard the core thesis of Berry many times, no one has really looked into the owned real estate assets of Berry Global. We believe that Berry owns as much as $2.5 billion worth of owned real estate. Berry (excluding RPC) owns 71 facilities in North America, 11 in Europe/Middle East, 3 in South America, and 7 in Asian/Australia. The Land, Building, and Improvement are carried on the books at $792mm. Typically, book value for real estate is very undervalued. Applying a 2-3x of this figure will yield a market value of $1.59bn to $2.38bn. Another way of arriving at a value is that the company has minimum $67mm of lease payments due 2019 for 35 leased facilities. Given that there are a total 135 facilities, $67mm of lease payment would imply a total lease payment of $258mm assuming a simple $67mm/26%. This is a simple back of the envelope methodology. Backing out the leased assets, the implied free rent is $191mm a year. Applying a 8%, 7%, and 6% cap rate on these assets yields a range of value in the $2.39bn, $2.73bn, and $3.18bn. These cap rates imply a EV/EBITDA multiple of 12.5x to 16.6x. Since Berry currently trades at 8.3x EV/EBITDA at roughly $47 per share, this is a huge uplift in EBITDA multiple. There are a few ways of looking at this.
1) Berry can sale leaseback these assets and reduce debt by $2.39 to $3.18bn. Net debt will rapidly drop to $2.16bn to $2.95bn. Granted tax leakage will total $335mm to $501mm. So Net debt will drop to $2.66bn to $3.29bn. Berry will also lower its EBITDA by $191mm since it will start paying rent. Netting out interest savings of $102mm to 133mm, means that Berry will lower its pre-tax income by $58 to $89mm. Applying a 21% tax rate, the net drop in taxed FCF is about $46mm to $70mm. Thus, the 2019 FCF will drop from $670mm to about $600mm to $624mm. However, Berry will no longer have a 4.0x debt to EBITDA ratio (Pre-RPC acquisition). It will instead have a 2.2x to 2.7x debt to EBITDA ratio assuming a new pro-forma $1.21bn of EBITDA ($1.4bn less $191mm). Pre-RPC, the EV/EBITDA multiple and P/FCF will be 7.36x to 7.9x. This is lower than the current 8.3x EV/EBITDA multiple on $11.6bn of EV and $1.4bn of EBITDA. P/FCF will actually increase to 10.0x to 10.4x. But it will come with a debt to EBITDA ratio is more inline with peer comps. Peers trade at much higher FCF multiples in general.
2) Another way of the looking at the real estate situation is that there is $191mm of free rent which deserves a 12.5 to 16.6x EBITDA multiple versus the 8.3x that the company is currently trading at. This is 14% of the overall EBITDA that is worth significantly more.
We have not seen other investor bring up the hidden real estate value play. Warehouses and industrial real estate is going through a renaissance right now with historically low cap rates. We encourage investors to bring up this point with the management team.
Investors Are Too Focus on Quarterly Performance
We have noticed that many shareholders are overly focused on the quarterly performance. We have sat in a management meeting with other shareholders when they literally tried to ask questions to triangulate what Berry will report the next quarter. We believe that if you mind the long term structural trends and pay less attention to the quarterly noise, one would do well owning Berry Global.
2008/2009 Plastic Packaging Performance
We spent some time looking at how recession resistant the plastic packaging industry’s cashflow is during 2008/2009. We looked at a handful of comps and when adjusted for swings of working capital, the comps demonstrated incredible resilience of cashflow during the financial crisis. Berry’s cashflow is very close to annuity like.
The big elephant in the room is Berry’s acquisition of RPC. The deal brings Berry’s adjusted EBITDA to $2.4bn. Berry anticipates it will bring debt/EBITDA ratio up to 5.0x and quickly de-leverage down to 4.0x in 2 years time. The market is a bit skeptical of the deal. If what Berry projects is true, then the FCF per share will likely approach $8 per share in 2021 after Berry reduce leverage to 4.0x. We assume $2.4bn of adjusted EBITDA, net debt going from $11.8bn to $9.44bn after 2 years of de-leveraging. $472mm of interest cost at 5% interest rate, $600m of cap ex, and 21% tax rate. This results in FCF of $1.05bn. Dividend by 133mm shares, this equates to $7.90 per share of FCF. At 5.9x 2021 FCF with 4.0x debt to EBITDA ratio, it is likely too cheap. Yes, it is levered. Even applying a 10x FCF multiple yields a $79 stock price. A 12x will yield a $95 stock price which is about 100% higher than today’s stock price.
Realizing cost synergy int he RPC Acquisition
Demonstrating a $8/share of FCF in 2021