Description

Investment Summary

Sealed Air (SEE) is undergoing a business and management transition.  It is a high quality company trading at an attractive valuation due to near term concerns and uncertainties.  The company’s gross margins (33%), ROIC and FCF conversion are at the high end of the packaging sector.  It should also be a higher growth company than peers given its ecommerce and food/protein exposure.  SEE has been posted to VIC in the past (7/2012, 1/2013 and 3/2017) and these write-ups provide good background on company history and business quality.  However, two key factors have changed in the last several months – first, the sale of Diversey to Bain and second, a CEO/CFO transition.  Investor sentiment is fairly negative given concern around higher resin input costs.

There is a reasonable degree of uncertainty over the next 3-6 months due to higher input costs (and therefore an expected FY17 earnings miss), a recently appointed CEO / CFO transition and disappointing trends at peers.  That said, I believe conditions for SEE going forward should be more favorable than the last 2-3 years (headwinds: FX, end market cycle, overly promotional management commentary to name a few) and the company is trading at an attractive valuation.  In addition, the company is now a pure play packaging company levered to attractive long term trends.  Most investors are familiar with Jerome Peribere’s early success and more recent challenges.  The stock tripled under his leadership but has been stagnant over the last three years.  The company’s sale of Diversey to Bain was completed in September 2017 and SEE is now a pure play food and product care company with a new management team.

Business

SEE is a global provider of packaging solutions.  Its products, such as vacuum packaging film, Cryovac and Bubble Wrap, help customers reduce waste, improve food safety and security, and protect products.  Food care is 65% of its revenue and product care is 35% of its revenue.

SEE has an attractive and sustainable business model (e.g. razor/razor blade, ability to push price / contractual pass through, consumable revenue stream).  Its long term results point to a relatively stable industry structure, margin profile and free cash flow conversion rate.  This is not to say the company and management have executed perfectly.  The past few years have been challenging due to FX and end market headwinds (Brazil for example), input cost volatility and poor investor communication.  I believe these headwinds should lesson going forward.

These tables are dated but provide helpful perspective.  SEE has historically earned higher margins and generated more free cash flow than peers.  The company’s ratios declined post the acquisition of Diversey in 2011 but have been improving.  Importantly, SEE’s margin and growth profile will be higher going forward without Diversey.

Management

On September 7, 2017, SEE announced Jerome Peribere is retiring on December 31, 2017.  Ted Doheny, formerly of JOY and IR, will succeed him as CEO on January 1, 2018.  I have not met Doheny but reviews have generally been positive.  He has been described as direct, detail oriented and cost/operations focused.  Doheny’s employment agreement is below.  Note part of his compensation is tied to SEE’s stock price through 2020.

https://www.sec.gov/Archives/edgar/data/1012100/000119312517279249/d453079dex101.htm

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There is also an opportunity for Doheny to address SEE’s elevated corporate costs, especially its stranded and unallocated costs tied to Diversey, relative to peers:

Carol Lowe, CFO, also recently departed.  This is not entirely surprising given the CEO transition.  Bill Stiehl has been named acting CFO.

Valuation

SEE is trading at 11.5x 2018 EBITDA pro forma for the Diversey transaction.  As of Q217, SEE had $1.9 bn remaining on its share repurchase program and planned to reduce debt by $1.1 bn upon transaction close.  Peers are trading at 9-10x 2018 EBITDA.  The valuation is more interesting on free cash flow.  I estimate SEE should generate ~$3.25 FCF/share in 2019 (13.5x FCF).  Consensus numbers do not yet factor in the full benefit of share buybacks.  The peer group has a median FCF multiple of 22x but the range is 13x to 39x FCF.  SEE is a higher quality and higher growth company than peers.  It also converts a much higher percentage of EBITDA and revenue into free cash flow (~50% FCF/EBITDA range versus ~40%).

“Looking beyond 2017, our targeted adjusted EBITDA conversion to free cash flow for continuing operations is 50%-plus.” – SEE Q117 call

I believe the valuation differential should close as investors become more comfortable with the pro forma SEE (incl. capital allocation policies), its new management team and its strengthening end market cycle.  Applying a 17.5x FCF on 2019 yields $57 or ~30% upside in the next year.

Source: Bloomberg

Risks

• Failed price increases to offset higher resin/input costs in 2017.  Management reiterated guidance on October 20, 2017 when the CFO transition was announced.

• Long term margin headwinds in product care due to higher growth in ecommerce.

• Poor capital allocation strategy (i.e. M&A, buybacks).

Catalyst

-Confirmation of 2017 guidance.

-Doheny communicates capital allocaiton strategy (buybacks, bolt-on M&A).

-Positive commentary around price increases sticking and assisting margins.