Description

(Note, figures above convert GBP at rate of $1.59 (per trading on 10/2/09). Consensus EPS is pulled from CapIQ, and is presented in GBP; EBIT is shown in $. EBIT and FCF are my assumptions, and share count / market cap / TEV are pro forma for recent rights issue.)

Rexam (ticker REX in London) has historically been a relatively steadily growing packaging company with a focus on aluminum cans, until its 2007 acquisition of Owens-Illinois' plastics business, which significantly bolstered Rexam's position in that segment of packaging. At around the same time, the company also announced the divestment of its glass business (sold to Ardagh Glass for £372mm) and the acquisition of Rostar, the Russian beverage can maker (purchased from RusAl for $297mm), thus repositioning the business as a beverage can maker with a substantial plastic packaging business. These transactions also left Rexam with a more levered balance sheet - O-I Plastic Products cost Rexam $1,825mm and the financing plan was to place 9.99% equity, raise a subordinated bond issue, and use the proceeds from the disposal of Glass. The company successfully issued €750mm (approximately £500mm) in bonds with an annual coupon of 6.75%, and exited 2007 with a net debt / EBITDA ratio of 3.4x and its investment-grade rating intact.

By the end of 2008, however, that debt ratio ballooned to 4.4x - this was in part due to negative FCF (driven by growth capex well beyond D&A and a number of working capital one-offs) as well as a large move in foreign exchange (£645mm impact in 2008). With trading conditions challenged in 1H09 - organic EBIT was down 20% - the company felt the need to improve its balance sheet in order to maintain its investment-grade credit rating, and it did so with a 4-for-11 rights issue in July raising approximately £334.3mm. As a result of these announcements, Rexam stock traded down to below £2.30 in early August (from almost £2.90 two weeks prior) and is currently trading at £2.626.

The opportunity in Rexam is in owning a market leader in a good business at a discount to peers which has been temporarily depressed due to: the rights issuance; downbeat comments by management; and, transitory cyclical softness (as discussed in the presentation linked below, a relatively small portion of sales - 25% - was responsible for a large portion - 75% - of the earnings weakness in 1H). This softness should represent an opportunity to generate earnings upside in a recovering economy - the key is a return to growth for some previously attractive segments, namely Russia (volumes down 32% this year), specialty cans / Red Bull (Rexam is the exclusive supplier of Red Bull's can, and weakness in that product caused specialty to be down 13%), as well as premium plastic packaging and closures for personal care customers such as P&G and Dior (where Rexam has suffered alongside its customers as consumers traded down in areas like make-up, previously assumed to be relatively defensive). Should these segments return to something approaching trend growth, top-line improvements coupled with cost savings initiatives - Rexam plans to deliver savings of £75mm by 2010 by reducing North American and European beverage can capacity and rightsizing Plastic Packaging - should lead to upside potential to consensus EBITDA and EPS for 2010 and 2011. More importantly, once Rexam demonstrates that it can work through these issues, we believe it should trade at least in line with peers Crown (CCK) and Ball (BLL) - for a price target in the range of £4.00.

http://www.rexam.com/files/presentations/halfyear09/slides.asp

Valuation

See below for relevant valuation metrics. Not included in the chart is projected FCF yield, which should be 12.5% in 2009 and 11.3% in 2010 (working capital benefits are not likely to be repeated next year). The adjustment has been made for the rights issuance (in this chart, cash raised through the rights is assumed to be held on the balance sheet while in the comp table found later in the post, I have reduced total debt as management intends to do with the proceeds).

 Financial Overview

Company Description

Rexam is the world's second largest consumer packaging company. It is the leading global beverage can maker, manufacturing 55bn cans per year, and one of the global leaders in rigid plastic packaging. Geographically, 38% of the business is in Europe , 43% in North America, and 19% in emerging markets. Rexam's plastics business serves the personal care market (lipstick and mascara cases, compacts, closures for fragrances, etc), the healthcare market (plastic containers, drug delivery devices, pharmaceutical valves, etc), and the food market.

Comparables

Note, FCF yield is LTM.

The closest comparables to Rexam are usually considered Crown and Ball as the three of them dominate the global can industry. As noted previously, Rexam trades at a material discount to these peers, and even below other packaging and/or plastics players (also listed in the table). Arguably, Rexam should trade in line with CCK and BLL - at 7.2x 2010E, Rexam shares would trade at approximately £3.86 (47% upside). Looking out to further improvements in 2011, and using the same multiple, Rexam would be worth over £4.20.

Near-term Catalyst

Management is in the process of meeting with investors, including hosting roundtable meetings in the US in October, with the CEO, CFO, and IR. The next earnings announcement is likely to be in November (press release only for Q3) followed by a fuller release and conference call in February (management presents half-year interims and final-year results; press releases for Q1 and Q3 results). Over the near-term this should be considered a low-catalyst idea with the emphasis on a normalization of valuation post the rights issuance. In later 2010, the key catalyst beyond earnings will be the renegotiation of their large North American can contract which is currently below company-average margins (~70+% of the company's North American can volumes).

Risks

• The primary risks are macro in nature but could impact Rexam disproportionately to peers:

o Russian beverage demand may or may not pick up (recent checks, including with MHK and ITW, suggest current demand still remains subdued and is not picking up in line with other countries)

o "De-premiumization", or the trend of trading down even for items like make-up, has impacted Rexam's customers and thus Rexam itself, as it has benefited from more extensive and elaborate packaging - is this cyclical or secular?

• Specialty can volumes are highly dependent on Red Bull; and, while Red Bull is an exclusive contract, it does come up again in 2011 (Rexam will very likely retain the business, but the question may be on margins going forward)
• Resin costs are pass-thru for 80% of Rexam volumes, but there remains some risk
• Very low visibility by the company may lead to some measure of conservatism when discussing guidance (they recently said they cannot see beyond 4 weeks, currently)

Catalyst