Wednesday, January 18, 2017

A current AIM Fund holding: Berry Plastics (BERY) by Andy Krueger. A BERY attractive stock with above average free cash flows for investors

Berry Plastics Group, Inc. (BERY, $50.90): “Profitable Packing is the Game, Berry Plastics is the Name”
By: Andy Krueger, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

Berry Plastics Group, Inc. (NYSE:BERY) manufactures value-added plastics for consumer packaging, hygiene, health & specialty products and engineered materials globally; however, the majority of revenue exposure (86%) is derived in the Americas.

• BERY’s CEO Jon Rich will retire as CEO in February 2017, although he will stay on with the company as the Executive Chairman.

• The acquisition of AEP was announced August 25 for $765 million in cash and stock and has a target close date of February 1.

• BERY’s diverse set of products defend against the slowdown in consumer spending and the food service market.

• Expectations for 2017 include additional reduction of debt to a sub 4x net debt/adjusted EBITDA, adjusted FCF of $550 million and organic sales volume growth of 1%.

Key points: BERY announced Jon Rich’s February 2017 retirement plans on September 30.  During the time since the announcement, the board of directors elected Tom Salmon to the fill the role of President and COO of the company.  Salmon will take over a company with annual revenues of $6.5 billion, 21,000 employees and 115 facilities globally.  Salmon joined the BERY team as part of the Covalence acquisition in 2007 when he was reassigned to serve as President of the Engineered Materials division.  After eight years of service in this position, Salmon became the President of Consumer Packaging, BERY’s largest segment.  Rich has fully indorsed Salmon publically.

The AEP acquisition is being funded using 50% cash and 50% stock.  BERY’s motive for the acquisition is twofold: AEP’s business provides a nice complement to the existing Engineered Materials division at BERY, and the acquisition will help lower BERY’s debt-to-earnings ratio.  BERY paid a 43% premium for AEP shares compared to the $77 closing price on August 24.

BERY offers a very diverse set of products, from plastic cups to pill containers, protecting the firm from a slowdown in select end markets.  The weak consumer spending environment and weakness in the food service market poses some near-term threat to BERY; however, the more stable end markets of consumer packaging and health, hygiene & specialty will be able to counterbalance the slowdown from the previously addressed factors.

The reduction of debt remains a top priority at BERY and the firm plans to achieve a sub 4x net debt/adjusted EBITDA figure before the end of 2017 by increasing the adjusted FCF earned by the firm and using the increase in FCF to pay down debt.  The adjusted FCF target of $550 million is pending the successful close of the AEP acquisition on February 1; any delays could reduce this estimate.  Companywide organic sales volume growth of 1% is projected to be achieved through 3% growth from the Health, Hygiene, & Specialties division, 1% from the Engineered Materials division, and -1% from the Consumer Package division.

Source: FactSet

What has the stock done lately?
Since Rich made his retirement plans public, BERY’s stock maintained its strong performance, up 15% to date.  BERY put together another strong quarter in fiscal Q4 as the company reported record highs in sales and operating EBITDA for any Q4.  A shift in strategic initiative to use assets to produce additional high-margin products instead of lower-margin products within the Specialty division caused volumes to decrease as margins and EBITDA increased for the segment and the firm.  Largely driven by the favorable tax accounting from the tax receivable agreement and NOLs from the Avintiv acquisition, BERY’s Q4 EPS of $0.73 beat the Street’s estimate of $0.59.  Unused NOLs of $500 million should continue to favor BERY in future reporting periods.

Past Year Performance: BERY closed the acquisition of Avintiv in October 2015 and since exceeded management’s expectations as synergy targets of reducing material and SG&A costs have already been surpassed with additional synergy opportunities yet to come.  BERY used diversification of product offerings to smooth the effects of inconsistent demand in certain end-markets over the past year.  Avintiv continues to have a positive effect while the AEP acquisition looks to perform just as well.

My Takeaway

BERY’s commitment to achieving a lower amount of debt on the firm’s books will make the company more flexible in the M&A market and ease investors’ concerns of tying up too much capital in interest payments.  Management has not released any news indicating the AEP close will be delayed; however, the financial benefits will be felt largely in 2018 as the additional $85 million in cash flow will be offset by the costs of the acquisition. 

BERY poses to lead their competitors in organic growth due to the firm’s scale and M&A activity as these factors provide pricing power and market consolidation opportunities for BERY greater than those experienced by the company’s competitors.  I expect these factors to continue to drive BERY’s share price higher as the firm’s leveraged business model continues to produce above average FCF and returns for investors.  I recommend that the AIM Equity fund maintain its position in Berry Plastics Group, Inc.

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