Description

Executive Summary:

*Note: IPL trades in CAD on the TSX, but values herein are presented in USD as this is the reporting currency

IPL Plastics Inc. (“IPL” or the “Company) is a plastic packaging provider. The Company manufactures specialty packaging products used in the food, consumer, agricultural, logistics and environmental end-markets. IPL Plastics IPO’d at $10 USD in July of 2018 and has since had headwinds and executional issues that have caused the stock to retreat to current prices below $7 USD. We believe the headwind and executional issues are temporary in nature and IPL is in a strong position to generate significant cash flow, grow volumes above markets, expand margins, and have a multiple re-rate. IPL is underfollowed (especially in the US) and we believe that IPL can have positive volume growth while generating operating leverage that allows double digit organic EBITDA growth. Based on our 2020 projected numbers, IPL trades at 6.5x EBITDA with a 15% FCF yield. With a high quality asset base, IPL represents a unique opportunity for 60% to 90% upside with little downside from current prices.

Company Overview:

IPL operates in the specialty rigid plastics. The Company generates 51% of revenue in the US, 21% in the UK, 16% in Canada, and 12% in the ROW. End markets primarily include food and dairy, industrial, waste management/environmental, agricultural, and consumer products. IPL has more than 5,300 customers with none representing more than 5% of revenue and has added more than 250 net customers per year over the past four years.

IPL has been very acquisitive since 2014 with acquisitions totaling $480 million dollars. These have largely been high quality niche assets that serve faster growing end markets. From our research, these acquisitions are generally viewed as positive by the industry. As of today, the Company has 14 manufacturing facilities, 7 corporate and sales offices, and 4 centers for innovation. Three of these are integrated into manufacturing facilities which can lead to new product development with lead times as little as six weeks.

Consumer Packaging Solutions (“CPS”) (31% of 2017 revenue, 37% of EBITDA)

Consumer Packaging Solutions (“CPS”) is the crown jewel of the business and has leading positions in IML injection molded containers in NA, environmental waste containers in NA and UK, and returnable bulk plastic containers in North America. They produce things such as tamper-evident and film seal packaging, lids and over caps, as well as custom packaging solutions. The food segment represents 90% of CPS revenues and the industry is expected to grow at 2-2.5%. Consumer, home improvement, and electronics make up the rest. The most important piece is the in-mold labeling or “IML”. This has been widely adopted in Europe and has just started to grow in North America. These end markets are expected to grow 4-5% as penetration rates in North America increase. As the number one player in North America, IPL is in a unique spot to capitalize on above market growth for the foreseeable future.

IPL made investments in increasing manufacturing capacity and capabilities where they have an active pipeline of new business. These investments will allow them to meet the growing demand for the IML products.

Pass throughs in this business range from immediate to quarterly depending on the contract. Long-term margin goals range between 18-20%.

Large Format Packaging and Environmental Solutions (“LF&E”) (48% of 2018 revenue, 48% of EBITDA)

Large format packing and environmental solutions (“LF&E”) produces large pails, containers and crates for food retail ag and industrial. They are the #1 environmental container manufacturer in Canada (60% share) and the UK (50% share) and the #3 plastic pail manufacturer in North America. This segment has significant growth opportunities and could see volume growth of 4-5% driven by adoption of environmental container adoption and emphasis on segregation of waste. Penetration rates for these bins remains low, especially in Canada, and as the leading player are in a strong position to capture this market growth.  For example, curbside collection has grown 90% over the past three years and still has a long runway.

This segment has pass throughs with a majority of customers and a number of fixed price arrangements in environmental containers. These products have short lead times and are re-priced with movements in resins

LF&E is undergoing a business optimization to improve margins and profitability by 2020. Management thinks they can get back to a 15% margin through cost optimization, sales strategy, pricing policy and models, customer management, customer service, customer profitability analysis, product profitability analysis, and simplification of SKUs. Cost management includes plant operations, down time, scrap rates, shift patterns, shift productivity, mold changes, complexity of processes, and freight/logistics. They have already reached this goal in the most recent quarter, and we feel confident these margins will be sustained.

Returnable Packaging Solutions (“RPS”) (18% of 2017 revenue, 23% of EBITDA)

Returnable packaging solutions (“RPS”) is the #1 bulk plastic container manufacturer in North America. They have patented injection molded containers and offer advantages compared to wood and cardboard such as durability/wear and tear resistance. This is a fast growing business with the opportunity to take share. They sell plastic bulk containers used in agricultural and automotive logistics market. The largest demand is from growers and packers in citrus, apple and onion markets. It has been a lumpy market with volatile results, but the current dynamics are setting up nicely to grow quickly.

The unique opportunity in this business is to penetrate other end markets. The Company has had success building a product for Ford in Europe and they have mentioned fourteen other OEM’s that have an interest in developing a product. In addition, they think they can enter protein packing and expand internationally. It is feasible that this segment can grow high single digits.

Resins have lags of 60 days for pass throughs in some customers, but a majority purchase on an order basis where prices are based on resin costs at the time. This is what leads to the lumpiness and volatility in margins. It should be a point of emphasis for management to better structure these contracts over time. Margins of 20% should be sustainable over time.

Executive Management:

• Average experience of more than 20 years in rigid plastic industry

• Executive compensation based on EBITDA, LTIP plan on total shareholder return relative to peer group, free cash flow ratio and a return metric (ROIC or ROCE)

• Generally thought of as high quality integrators and long-term thinkers

• CFO is very cost oriented

Why Does the Opportunity Exist?

Cost Inflation: In 2018, IPL faced raw material inflation that compressed margins given the normal time lag required for contractual pass-through arrangements to pass through the cost inflation. In total, ~65% of total resin is on pass-through contracts that vary in length by segment. These issues led to a sell-off that was magnified by the general market weakness in Q4 2018. In recent quarters polyethylene / polypropylene (“PE/PP”) prices have stabilized and cost recovery has begun to show in the margins, yet IPL is still getting no credit. In addition, from our research we believe long-term dynamics remain strong for purchasers due to continued capacity additions increasing supply.

Optimization Plan: During the fourth quarter of 2018, IPL initiated a business optimization plan to improve margins and profitability by 2020. This included establishing a centralized resin purchasing unit and improving operations in the LF&E segment. The centralized purchasing unit has shown early success and should provide less volatility in margins going forward. The LF&E optimization included cost reductions, sales strategy, pricing policy, customer management, profitability management, and SKUs simplification. The LF&E optimization has had success so far as 1Q19 margins increased from 9.7% to 16.5% over the past two quarters and is above target range of ~15%. As they continue to execute, EBITDA and cash flow generation will improve.

Third-Party Issues/NPD: IPL has recently developed a plastic bin for use by auto OEM’s to transport large quantities of parts and products. The product was a success with Ford, but a third party logistics supplier wasn’t able to meet the demand. Ford also reduced its Europe expenditures which is where the product was rolled out. This led to lower margins and volumes in the quarter. IPL believes these problems are fixed and have also received interest from 14 other auto producers to roll out similar products. These continued innovations will help the RPS segment return to volume growth.

Weather/End Markets: Due to the operating leverage in the business, weakness in end markets can have a significant impact on margins. This was what happened in the RPS segment in the first quarter. Due to the wet weather, ag producers delayed/didn’t order products due to lower output volumes. This caused margins in the segment to decrease over 800bps y/y and down 1000bps sequentially. These issues are temporary, and as they normalize this segment should return to higher profitability. The results showed in 2Q and management continues to see strong order growth in 3Q. The CPS segment has also showed some volume weakness recently due to issues with a few large customers. We see this inflecting as IML continues to grow and these issues sort out as is seen by a large customer win in the quarter.

Growth Investments: Since the beginning of 2017, IPL has increased CapEx to meet the growing demand in end markets. These expenditures have totaled $100 million vs. the $20 million of maintenance expenditures over that same period of time. 2019 is the end of a bulk of these investments, and IPL should show an inflection in free cash flow generation as CapEx is reduced to 25-30% of EBITDA and the investments start to flow through into the P&L. These growth investments have target IRRs of greater than 15% or a payback period of less than 5 years. 

Illiquid Microcap: Setup is also interesting as it is a struggling IPO that is illiquid (47,000 shares ADV). The Ireland-based management team have not done a great job communicating with shareholders. With limited public history, this is leading to many investors waiting on the sidelines. This sets up nicely into 2020 as the execution shows in the numbers and with a closely held float, the stock could appreciate very quickly.

Investment Opportunity:

• Margin reversion as the company continues to execute on initiatives

• Above market growth driven by leading positions in niche markets

• Free cash flow inflection as large amount of growth investments normalizes and Company is able to de-lever the balance sheet and make opportunistic M&A

• Increasing penetration rates of In-mold labeling in North America

• Segregation of waste driving municipality purchases in LF&E

• Stock will become more well known as public company operating history lengthens

• Strategic takeout candidate with high quality assets and strong cash generation in a consolidating industry

Valuation: The issues above have led to an extremely attractive upside/downside scenario. We believe IPL will provide unique access to niche plastic end markets that will see low to mid-single digit volume growth and margin expansion towards 15% as the business straightens out the operational issues and industry headwinds succeed. In 2020 and beyond, the business is set up to have an inflection in free cash flow generation that will de-lever the business, allow for reinvestment, and take advantage of M&A opportunities. Simplistic valuation scenarios for 2020 are as follows:

Base Case

Revenues increase in 2020 to $730 million driven by return of organic growth volumes and a full year of the Looman’s acquisition. Consolidated EBTIDA margins reach 15% which generates $111 million of EBITDA and free cash flow of $57 million which translates to a yield of ~15% on current market cap. An 8.5x multiple gives a share price of $11, 63% upside.

Upside Case

Stronger revenue growth to $740 million in 2020 driven by new customer wins in CPS, municipal wins in LF&E, and increased auto revenues in RPS. Margins reach upper end of managements long-term estimates with 17% consolidated margins. $123 million in EBITDA and free cash flow of $66 million for a yield of ~18%. 8.5x multiple gives a share price of $12.90, 92% upside.

Stress Case

Continued issues in end markets and execution leads to little growth and $700 million of revenue in 2020. Loss of operating leverage and execution issues lead to margins of only 12%. EBITDA declines to $86 million and free cash flow of $39 million for yield of roughly 11%. At 8.0x EBITDA, share price is $6.30 for 6% downside.

Risks:

• Raw material inflation

• Failed acquisitions

• Negative volumes

• Increased competition in end markets

• IML penetration rates flatline

• Failure to re-rate due to negative sentiment around plastic use

Catalyst

• Inflection of free cash flow as excess growth investments are finished
• Margin normalization
• Increased following and public company operating history
• de-leveraging the balance sheet
• return to volume growth