Description

PTVE (Long): $18.48

Market Cap: $3.2B

EV: $6.6B

Upside: $37.50 (+102%)

Downside: $12.00 (-35%)

ADV: $15M/day

Summary

Pactiv Evergreen (PTVE) is a blue-chip packaging company that, due to a broken IPO, has been left steeply discounted in the current market.  The business is ESG friendly, a COVID rebound play and a self-help story that sports a ~20% levered FCF yield in 2022 (chosen as a valuation marker as it is the first full year of no COVID impact).  We think the pitch rests largely upon 3 main pillars: 1) self-help from the already underway capex program will drive efficiencies going forward 2) reopening post-COVID should provide a meaningful tailwind to the EBITDA in 2021 and 2022 3) using cash flow to delever the balance sheet should drive meaningful debt to equity value creation in the next 3 years. We think PTVE is worth $37.50 in 2021 vs the current share price of $18.48, representing ~100% upside to the current stock price.

The Trade

The company will see a meaningful FCF inflection in 2021 as a re-opening of the US economy drives growth in their impacted packaging end markets (schools, sporting events, airports, catering) and the company’s investments in plant automation begin to bear fruit.  We see the FCF story here as particularly springloaded: adding up EBITDA gained from efficiency, improving fundamentals and FCF deployed to delever the balance sheet should all drive rapid accretion to levered FCF.  The beauty of the trade is PTVE doesn’t need to do anything other than operate and deliver the savings they have forecast and reinvest that cash flow to pay down debt.  Furthermore, EBITDA was $917mm in 2017 so returning to that level once adding the incremental efficiency capex should not be a stretch goal.  We expect PTVE to establish a record of execution over the next two years and exiting 2022 with substantially less leverage (2.6x at YE 2022), a leaner capex budget, and a target of ~$1B in EBITDA.  If we are right, by 2022-23, PTVE will start returning meaningful capital to shareholders (1.6x net levered at end of 2023).  One of the keys to the free cash flow conversion, despite investing materially more capital than maintenance levels (more than double), is the low cost of debt.  Despite material current leverage, PTVE blended cost of debt is around 4.5%.  PTVE will also finish the year with ~$2B in NOLs, which will offset all taxable income incurred during our forecast period (and a little bit beyond).

If we’re wrong, we estimate the downside to be around $13.75. We get this by assuming the capex programs don’t deliver or covid impacted volume don’t return and the company gets a 7x multiple off 2022 EBITDA of $800M ($100M below current consensus and $130M below our estimate).   

Why does this situation exist?

Coming off a broken IPO (priced at $14.00 in September and fell 22% the first day) the technicals were broken from the outset and purely looking at historical financials, the business looks like it’s been broken for a few years. Adjusted EBITDA fell from $916mm in 2017 to approximately $625mm in 2020. The company suffered from operational issues including $73mm in short-term labor shortages, $74mm tied to a shortage of truck drivers, $33mm in increased raw materials, and operational issues at their two beverage merchandising mills.  We believe the company has a strong management team (CEO has been with the company for over 25 years) and we expect them to execute going forward and don’t believe these issues are a result of company mismanagement. This year, the company is getting impacted negatively by COVID to the tune of $200mm in EBITDA, which we expect them to recover over the next 2 years.

The Business

Pactiv Evergreen is the combination of two well-known packaging brands: Pactiv, which was public until its 2010 acquisition by Rank Group, and Evergreen, which was owned by Carter Holt Harvey, a New Zealand fiber conglomerate and has its roots back to International Paper’s liquid packaging business. 

PTVE’s main competitor is the Dart Group, a private company with a broad portfolio of foodservice packaging products - including Solo Cups.  PTVE’s business isn’t dominated by a single substrate (like metal, plastic, paper, etc) - but instead offers many solutions across both plastic and paper, allowing the company to act as a “one-stop shop” to customers who are evaluating different products to address myriad packaging and, increasingly, ESG concerns.  It’s worth noting that Pactiv was Evergreen’s largest customer before being brought together under Rank, so some level of product integration was already in place.

With that preamble out of the way, their business is making cups, plates, utensils, food containers, etc. in plastic and cardboard-like materials.  But far from being a run of the mill supplier, the logos represented by PTVE’s solutions are blue-chip multinationals, per the S-1: 

“we were the #1 supplier to many of our customers across our product categories in the aggregate, including four of the five largest foodservice distributors, eight of the ten largest supermarket chains, three of the four largest dairies, and the three largest QSR groups. We were also the #1, #2 or #3 packaging supplier to six of the eight largest meat and poultry processors.”

They are the largest foodservice packaging supplier to an impressive customer list that includes McDonald's, Starbucks, Chick-fil-a, Burger King, Tyson, Conagra, US Foods, Sysco, Walmart, Danone Wave, and many others.  Perhaps due to such an illustrious customer list, no single customer is >10% of revenue.

The Segments

Foodservice:  PTVE’s largest segment, Foodservice primarily provides packaging solutions for quick service restaurants and food distributors with the largest products being cups/lids (~40%) and containers (40%), with the remaining 20% in ancillary products such as trays and utensils.  This business has been materially impacted by COVID and we expect once restaurants, sporting events, schools, etc. reopen we expect it will rebound to prior levels of profitably, particularly given the investments PTVE has made in efficiencies.

Food Merchandising:  Products for food retail (i.e. grocery).  Everything from plastic containers for rotisserie chicken to eggs to CPG packaged foods.  Less impacted by COVID and contains a mix of plastic / paper materials from both legacy Pactiv and Evergreen.

Beverage Merchandising:  This business has its roots in the legacy Evergreen business and is particularly strong in cartons for non-dairy milks (they do milk too, but non-dairy milks like Soy, Oat, Almond are very fast-growing).  Like other paperboard names, this business is particularly sticky because the customers have PTVE equipment embedded in their plant, with PTVE then selling the paperboard and other products to run those machines.

People Love Plastic Packaging but it’s not considered “ESG” - PTVE is different

One criticism we have heard about plastic packaging companies like Berry Plastics is the environmental concerns over plastic will eventually erode many of their current end markets.  First it’s banning straws, then they come for plastic utensils, and eventually everything is metal or paper, despite the increased expense of those substrates. BERY trades at ~7.5x EBITDA as a largely pure-play plastics company, while SLGN has a roughly 50-50% plastic-metal mix and trades over 9.0x, in part, we believe, because SLGN’s substrates are more sustainable but also because they can offer customers a wider assortment of products with different cost and qualifications across a wide ESG and performance spectrum.  This flexibility makes SLGN a more valuable partner to their customers and that value is reflected in their growth rate and multiple.  

PTVE’s product line today is 65% sustainable with a goal to be at 100% by 2030.  They have invested in sustainability innovation as part of their capital program and we think being able to offer new, environmentally friendly SKUs as part of a broad offering will be key to outgrowing underlying markets in the years to come.  With multiple substrates, PTVE expects to benefit as their customers become more environmentally conscious and upgrade to higher margin products.

Looking at the model differently: Bridging to EBITDA potential 

In addition to the model above, we also developed the following bridge to help “sanity check” our assumptions regarding EBITDA projections, we also include a 2019 to 2020 bridge walk through the impacts of COVID and the unwind of some prior headwinds. Hopefully, this helps you understand the cadence from 2019 to the current COVID impacted 2020 number, to where we think they get to in 2021 when some of the benefits start to flow through the model and COVID volume impact partially rebounds.

Strategic Capex program

Below find PTVE’s strategic capex program from the S-1 whereby they bucket their capital spend and the expected payback for each project.  The company typically gets a 2 year payback on a variety of initiatives from innovation to supply chain to automation.  We expect the company to continue to identify areas of spend, but it will revert to a more “normal” level of spend in 2022.  This “continual improvement / cost out” program is common in packaging, and we expect payback times to stretch as they fall into this more regular cadence, but it will still be a very attractive source of EBITDA growth.

What will Rank Group Do?

We are asked this question frequently, so it’s probably worth addressing upfront: we don’t know Rank’s intentions.  Graeme Hart is a thoughtful investor and purchased 3.6M more shares in the IPO, which we think reaffirms his commitment to the transformation at hand here and the opportunity, but that is speculation on our part. 

I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts

Q4 earnings with 2021 guidance

Improved demand environment as US economy re-opens following broad vaccination

Continued debt reduction

I do not hold a position with the issuer such as employment, directorship, or consultancy.

Risks

Raw materials - While raw material is always a risk (polystyrene represents 50%, polypropylene is 30% and PET is 20%), the company has automatic pass-throughs for 80% of its resin based revenue with an average lag of 120 days

Customer concentration - PTVE’s 10 largest customers account for 37% of revenues

Coronavirus - In the event of a second wave or lack of vaccine, PTVE’s commercial foodservice business may remain challenged