Description

Crown Holdings (CCK) is a word leader in metal packaging—primarily beverage cans and food cans.  The company survived a near death experience earlier in the decade for a combination of reasons well-chronicled in a VIC analysis dated early in 2004.  By the way, the stock has generated an IRR of almost 30% since that point despite its recent lackluster performance. 

This is a simple story:  High cash generation in a largely international, oligopolistic, recession-resistant industry with management that has done the right thing over the last five years and is rewarded to do the right thing—incentive programs are chiefly tied to year to year improvement in return on invested capital.  On my estimates, CCK will generate a 10.5% free cash flow yield next year.  Management is on record as saying that they will begin to devote a higher percentage of free cash flow to share buybacks as net debt:EBITDA reaches the 3:1 threshold.  In 2006 and 2007 roundly 1/3 of FCF has gone toward buybacks with the rest toward debt repayment; this should rise to 2/3 in 2008, or about 6% of the current share base assuming a mid-$20’s purchase price.

Looking out three years to the end of 2010 as an investment horizon and assuming CCK continues to buy back stock with 2/3 of its free cash, the company would have 140MM shares, a reduction of 17% from current levels and, of course, the balance sheet would be somewhat stronger. By then, free cash/share should have risen to $3.30.  Using the same capitalization rate as today that would produce a 13% compounded return—OK but not great.  If one assumes, though, that the FCF yield drops to 8%, the stock would go to $40, of a compounded return of 21%/year.  I think that’s very attractive for a business with relatively low risk characteristics.

Business Dynamics:

After a series of divestitures In recent years, CCK is almost entirely focused on beverage and food cans.  Worldwide, Crown is #1 in food cans, #1 in aerosol cans, #2 in metal vacuum closures, and #3 in beverage cans. There are high barriers to entry across the business mix and shipping product long distances is uneconomic.  Both markets have evolved into oligopolies over the last decade.  As noted above, Crown is very international and thus a beneficiary of the weaker dollar:  In 2006, 72% of sales were outside of the United States and rapid growth in emerging markets should push this number higher going forward. In the last couple of years, for example, new plants have been opened in Cambodia, Vietnam, Kazakhstan, Tunisia, Saudi Arabia and Brazil among others.  Crown’s long commitment to emerging markets is not rivaled by its competitors and is a real strategic asset.

Management is adamant that Crown is not interested in acquisitions and has ample opportunities for internal growth.  Essentially, mature businesses in the US and Western Europe where cash flow significantly outstrips spending requirements fund growth in emerging markets with ample cash left over for balance sheet improvement and shareholders.  Crown will spend roughly $150MM  in both 2007 and 2008 against D&A of $225MM.  (Thus if CCK earns $1.50 in 2007, cash earnings really are $1.95/share).  Part of the reason for this is overbuilding in the 1990’s and part the company’s high degree of conservatism in expensing even major maintenance spending. 

Crown actually has a good record of innovation which is important in such a prosaic industry.  One example is it’s patented Superend beverage product, which uses 10% less aluminum than rival beverage can ends and also has attractive consumer attributes.  Another is its shaped can technology, such as the Heineken keg can.  These products boost margins and also help cement relationships with major customers.  At the same time, it is highly unlikely that anyone in its competitive set, including plastic packaging, will come up with a breakthrough that truly alters industry dynamics.

Metals Pricing:

Crown and its competitors have been impacted in the past by sharp fluctuations in steel and aluminum prices and the industry has worked hard to lessen the impact.  In the steel businesses, Crown negotiates annually with customers on metal pricing.  At the recent Bank of America Conference, CEO John Conway noted in talking about higher steel prices, “There’s no reason in our minds why we shouldn’t be successful in pushing through price with our customers.”  I would note that Mr. Conway is quite conservative in his observations.  In beverage cans (aluminum) globally, it is a passthrough formula.

Risks:

1. Sudden and sharp dollar strengthening. 

2. Steep decline in carbonated beverage consumption.

3. Dumb acquisiton (I think highly unlikely).

4. Asbestos:  I believe is minimal now but the number of claims could  conceivably reverse path and climb steeply.  If readers are interested I can expand on this issue but I don’t think it is a big risk factor.

Catalyst