Description

Summary: After a difficult period, shares of SEE (formerly known as Sealed Air) have fallen to the mid-$30s from the mid-$60s over the past two years and now trade at an attractive valuation. I think the business is poised to improve and that the stock has about 40% upside to my valuation of $51/share.

VIC Reports: Four reports on SEE have been posted on VIC in the past, with two most recent ones in March and November 2017. The key issue in 2017 was the divestiture of Diversey, an industrial cleaning products company. SEE bought Diversey in 2011 for $4.3 billion, but it proved to be problematic and was sold to Bain in 2017 at a lower price of $3.2 billion. SEE also underwent a CEO transition around this time, with Ted Doheny taking over at the beginning of 2018. There are similarities between now and then as SEE is, once again, dealing with a potentially troubled acquisition and a CEO change.

Takeover Speculation: On Feb. 23, Street Insider reported a rumor that Berry Global (BERY) has hired bankers and may make a bid for SEE. Berry is a direct competitor of SEE in the protective and packaging space. Berry’s market cap is about $6.9 billion vs. $5.3 billion for SEE, so it would be a tall order for Berry to complete this deal in our current higher-interest rates world. Street Insider’s report also speculated that KKR might be interested in acquiring SEE.

I don’t know if a deal will happen, but it makes some sense given recent problems at SEE and its attractive valuation. I started writing this report a few weeks ago. I was going to hold off on posting it until after the Q4 numbers are released on Feb. 27, but I decided not to wait just in case something does happen. The Q4 results are likely to be a non-event as expectations are low.

Company Description: SEE is a packaging company that originated in 1960 with Bubble Wrap, a household name today. It has expanded through many acquisitions over the decades, and now operates in two broad segments: food and protective. SEE’s products are used in many different categories, including food, fluids, medical, electronics, transportation, and more. Its brands include Bubble Wrap (protection), Cryovac (food packaging), Sealed Air (packaging), Liquibox (liquids packaging), prismiq (packaging and labeling technology), and Auto Bag (automated packaging). Cyrovac accounts for about 65% of SEE’s total revenue, with the largest individual product being protective packaging for proteins, especially beef. This is a sticky market due to the necessity of keeping beef fresh and Cryovac products are integrated into many meat processing plants. The downside is that since red meat accounts for roughly one quarter of SEE’s total sales, its results are overly exposed to the health of the beef market. SEE operates in 120 countries, but the U.S. accounts for about 54% of sales. Its areas of growth include automation, digitalization, and sustainability.

SEE employs a razor/razor blade model as its products are integrated into its customers’ supply chains and it sells consumable items. Due to this model, its prices and margins are relatively stable, even in times of lower demand from customers. Its customer relationships are also sticky.

Segment and Geographical Info

As seen below, food accounts for about 64% of SEE’s revenue and EBITDA, with the rest attributable to protective. The increase in food revenue and EBITDA is partly due to the addition of Liquibox in 2023 (discussed below). Food tends to have higher EBITDA margins than protective.

Recent Struggles

The economic surge that followed the worst of the pandemic led to strong demand for SEE’s products in 2021, especially in the protective category. Consequently, SEE had a strong year, which resulted in its stock hitting an all-time high of about $70/share in January 2022. However, it soon became apparent that its customers’ inventories had become bloated. As 2022 progressed, sales volumes in protective and, to a lesser extent, food weakened due to inflation, supply challenges, and destocking by customers amid a slowing industrial economy.

In early 2023, with these industry conditions continuing, SEE acknowledged that it was facing a tough first half of the year, but it promised a recovery in the second half of the year. Unfortunately, this view turned out to be too optimistic, and SEE’s management was forced to lower guidance twice. SEE’s adjusted EPS for 2023 should come in at about $2.90, down from $4.10 in 2022. Consequently, SEE’s stock has dropped 24% over the past year and nearly 50% from early 2022 high; its share price has greatly underperformed that of peer packaging companies over the past two years.

As it was dealing with this downturn in 2023, SEE was integrating Liquibox, which it acquired last February for $1.15 billion in cash (financed almost entirely with new debt). Part of SEE’s food division, Liquibox is a manufacturer of fluids and liquids packaging and dispensing products, making it complementary to Cryovac’s operations in this area. For example, Liquibox is a leader in bag-in-box products, such as wine that is placed in bags and then dispensed through a tap in a box. In 2022, Liquibox generated sales of $353 million, while Cryovac’s fluids business had $239 million in sales.

The acquisition valued Liquibox at a rather aggressive 3.2x sales and 13.5x EV/EBITDA; for comparison, SEE itself presently trades at an EV/sales of about 1.8x and EV/adj. EBITDA of 9x. At the time of deal, SEE claimed that it would achieve $30 million in cost synergies within three years, thereby reducing the implied acquisition multiple. Unfortunately, just a year later, the Liquibox deal appears to be a disappointment as its revenue has dropped about 17% over the past year. In earnings calls, SEE’s management has blamed the disappointing results on unspecified operational challenges and the slowdown in demand in the food and drinks category. Perhaps more significantly, it has also mentioned that Liquibox’s former owners intentionally simplified its portfolio and ended up losing customers because of it. Indeed, it appears that some of these customers ordered products in 2022 but then switched to other providers in 2023 – something that SEE’s management probably should have caught in due diligence. SEE is dealing with this issue by investing in liquids and bringing back some discontinued Liquibox products, as well as integrating Liquibox with its existing Cryovac products.

So…facing a tough year and a declining stock price, SEE announced in an October 2023 press release that Ted Doheny would be stepping down after nearly six years as CEO. The move was unexpected, as Doheny had signed a five-year contract extension in the previous year. In the release, SEE’s chairman was quoted as saying, “…the Board recognizes there is more work to position SEE for long-term profitable growth.” It’s not much of a stretch to assume that the change was made due to the poor 2023 results and the questionable value of Liquibox. With Doheny out, SEE named COO Emile Chammas and CFO Dustin Semach as interim co-CEOs while it searches for a permanent leader. Chammas has been SEE since 2010, but Semach just joined the company in April 2023. He has a tech background, which should be useful as technology is an important part of SEE’s growth strategy.

Tax Issue: In April 2023, SEE deposited $175 million with the IRS as part of a tentative settlement of a tax dispute. In 2014, SEE settled asbestos cases that dated back to when Cryovac was owned by W.R. Grace. SEE deducted the amount of the settlement ($1.49 billion) on its 2014 taxes. In 2020, the IRS determined that the deduction was improper. SEE agreed to a settlement rather than continue to fight over the issue. This settlement wiped out nearly all of SEE’s free cash flow to equity in the first 3 quarters of 2023. Although the settlement is not yet final, it is expected that there will be no further liability in this case.

Opportunity

SEE’s strengths include its resilient margins, strong customer relationships, and potential for growth through automation.

While SEE’s packaging business has been weak of late, more than 60% of its revenue comes from its food operations. Spending on food in the U.S. has been rising despite inflation. That said, SEE’s exposure to the beef market has been a problem as consumers have shifted to other, less expensive proteins. Beef prices are moderating, so demand from this important segment should improve. Moreover, SEE reports that it has recently won new business in proteins with its automation equipment. In the long run, the company’s exposure to proteins could benefit from the rise of the global middle class as wealthier consumers tend to eat more meat.

Despite the recent issue with the beef market, SEE has a long history of supplying quality products to food processors that provides confidence in a turnaround. The company has strong relationships with its customers and a huge variety of products to meet their needs. SEE’s customers have little incentive to change suppliers as their need to use proven, quality packaging to prevent spoilage or contamination and comply with food safety regulations is more important than the cost of the packaging. Thus, there are significant switching costs that keep SEE from losing customers and allow it to charge premium prices. That said, food pricing realized for SEE has been lower of late due to customer and product mix.

One of the key parts of SEE’s food business is that it not only provides the consumable packaging products, but it also supplies them with a significant amount of equipment. SEE’s management has said that more than half of its packaging materials are used with its machines. Some of them, in fact, can only be used with the company’s machines. As some of its equipment can be used for decades, SEE has an impressive razor/razor blade model that provides for pricing power and very sticky customers. Many of its customers would need to change their manufacturing processes to switch to a different supplier - a risky, time consuming, and expensive process. Moreover, SEE can upsell more machines to its existing customers over time. One of the company’s main opportunities is in automation. Food processing is a labor-intensive business, and SEE’s customers are looking for ways to speed up production, use fewer workers, and improve consistency. As SEE develops more automation equipment, its large base of existing food customers provides it with many sales opportunities. In Q3, SEE estimated that its equipment, parts, and services sales to food customers rose more than 15%, while its sales of automation products increased about 30%.

Meanwhile, SEE’s protective packaging business should recover unless the U.S. economy falls into a recession. This segment is diversified across many industries but is broadly tied to the industrial business cycle in the U.S. and other countries. While protective volumes have declined, I think this has less to do with SEE than its customers’ issues. As these issues clear up, demand for the company’s products should improve. SEE’s products are often as integrated into the production model for its protective business as much as for its food processors. Like its food customers, SEE’s protective customers do not want any downtime and speed is critical.

SEE’s protective products are likely more commoditized than for food as the need for the highest-quality stuff is probably lower. Moreover, SEE’s protective customers are often smaller than the large processors that buy many of its food products. Consequently, protective products face more pricing pressure and have generally lower margins. SEE is fighting against these dynamics by improving its automation and digital offerings as packaging (like everything else) integrates more technology. This technology can provide material savings in time and labor expense to even small customers.

Strategy/Capital Allocation

SEE introduced a strategic plan in 2018 called Reinvent SEE that focused on automation, sustainability, digital products, and more. In 2023, it announced Reinvent SEE 2.0 that included these same key areas, but with a greater focus on fluids and liquids (Liquibox, Cryovac), digital packaging and printing (prismiq), automation hardware, its new e-commerce platform, and simplifying its organizational structure.

SEE’s model calls for annual sales growth of 5%-7%, including Liquibox and other possible acquisitions. It calls for EBITDA growth of 7%-9% based on operating leverage (higher sales), price increases, higher volumes, cost reduction, savings from shift to digital, and synergies from Liquibox. If SEE can reach these goals, its yearly EPS growth would likely exceed 10% due to share buybacks and lower interest costs as it pays down debt. SEE did not reach these goals in 2023 due to the slowdown in demand and disappointing results from Liquibox.

SEE has projected that if can reach about $1 billion in automation-related revenue in 2027, about double the current level. Its online business has grown from only about 5% a couple of years ago to about 14% today. SEE claims that it can be 80% online in about three years.

Thus far, SEE has had mixed success with these efforts, but, of course, there was a pandemic. The company needs to capitalize on its strengths and generate more sales growth. Going forward, it intends to invest about 4%-5% of its sales in capex, with key investments in recyclable products, carbon reduction technology, touchless automation, digital products, and cost efficiency efforts. While investing in these areas, SEE intends to pay down debt and return capital to shareholders through dividends and buybacks.

SEE only generated $7.5 million in free cash flow to equity in the first 9 months of 2023, but this amount included the $175 million tax payment. Excluding this payment, its FCFE would have been $182.5 million, an increase of 33% from $137.3 million in the same period of the previous year. SEE’s FCFE for all of 2022 was $376 million, a significant drop from the average of $526 million in 2020-21. Based on SEE’s FCF conversion rates and my estimates, its FCF should exceed $450 million in 2025.

SEE’s current annual dividend is $0.80/share. At this level, its annual dividend cost is about $116 million. My assumption is that SEE will hold its dividend at this level through 2025 to save more cash for debt reduction and share buybacks.

SEE repurchased 1.53 million shares for $79.9 million in Q1 2023 but did not repurchase any shares in Q2 or Q3. It still has $536.5 million left on its authorization.

SEE closed Q3 with $4.9 billion in debt and about $300 million in cash. Considering my estimate of 2023 adj. EBITDA of $1.1 billion, its net debt/adj. EBITDA is about 4.2x. SEE had originally targeted leverage < 3.5x by the end of 2023, but its EBITDA was about $150 million-$200 million lower than originally expected. The company should be able to pay down about $200 million in debt in 2024 and significantly more in 2025 and beyond. The company could get its leverage down to below 3x within about three years. In November, SEE sold $425 million in senior notes that mature in 2031 to pay off debt that was set to mature in 2024. The interest rate on the new debt is 7.25%.

SEE could make more acquisitions, probably in the automation space. Its last major deal before Liquibox was the purchase of Automated Packaging Systems (APS) for $510 million in 2019. APS brought the Autobag bagging machine and recyclable film products to SEE. If another deal is on the horizon, it would probably be something in this area. However, SEE doesn’t even have a permanent CEO now, so one would think that a big acquisition is unlikely to happen soon.

Income Statement:

SEE’s adjusted EPS reached an all-time high of $4.10 in 2022, but it dropped below $3 in 2023 as its revenue and operating margin dipped and its interest costs rose. SEE’s interest expense has risen due to its floating rate debt and the purchase of Liquibox. This expense should come down as it pays down debt over the next couple of years. I’m expecting limited sales and EPS growth in 2024 due to depressed demand and ongoing restructuring. At some point, I think investors will begin to focus on the possibility of better results in 2025 and beyond.

SEE is currently implementing a cost reduction program to save $140 million-$160 million per year in operating expenses. The cost reduction program is going to bring $115 million in one-time costs, including about $80 million related to layoffs. SEE is behind schedule on this cost savings – it was only about 25% towards its goal as of the end of September despite reducing its labor force by about 600 people.

Balance Sheet:

Investors have punished SEE for the debt that it incurred to buy Liquibox. SEE has about $4.6 billion in net debt at present, but this number should decline as debt paydown is a priority. SEE has ample liquidity, including a $1 billion line of credit.

Cash Flow Statement:

SEE issued new debt to acquire Liquibox in 2023. It also had a large tax settlement. Its cash flow should improve as these were one-time events.

Valuation

SEE’s adjusted EBITDA fell to about $1.1 billion in 2023 from $1.2 billion in 2022. Excluding the benefit from Liquibox, it would have been about $1.0 billion. Given the current difficult trends, I don’t expect SEE’s EBITDA will get back to $1.2 billion until 2025 or 2026. Over the past 10 years, SEE has traded at an average EV/EBITDA of about 12.5x.

I’ll value SEE at an EV/EBITDA of 9.5x on 2025 expected EBITDA. Assuming debt paydown, this yields an equity value of about $51/share, providing about 40% upside. This is hardly an aggressive target in my opinion – SEE traded above $50/share as recently as February of last year. Even so, the sellside analysts have mostly given up on SEE given the depressed results and the ongoing restructuring. Their average price target is around $40/share.

Risks

·         Macroeconomic weakness

·         Customers shift away from plastic packaging to paper

·         Customers develop their own packaging or automation solutions

·         Liquibox continues to underperform

·         Significant debt, floating-rate interest

·         Doesn’t have a permanent CEO in place

·         Costly restructuring may not pay off

·         SEE could make more acquisitions that may not work and could delay deleveraging and share buybacks

Conclusion

SEE has had disappointing results over the past year but it is typically a stable business with sticky customers, good margins, and high barriers to entry. I think it is undervalued and could be a takeover candidate. I think there is 40% upside in the stock.

Catalyst

improved results, new CEO, possible takeover, share buybacks, debt reduction