After being down more than 40% during the market sell-off in mid-March, Berry Global Group (BERY) is now up approximately 17% year-to-date. However, even after the strong rebound in its share price, Berry still trades at what we believe is value territory, making this a compelling investment case. The company currently trades at 9.3x forward earnings and at a P/FCF multiple of 7.7x using management’s guidance for $925m in FCF at the mid-point.
We believe there are two main reasons why the market might be pricing Berry at a discount. In 2019, the company completed its biggest acquisition yet, with the purchase of RPC Group Plc for $6.5 billion in an all-cash transaction. The acquisition added approximately $3 billion in sales to Berry’s top-line or an increase of approximately 40% overnight. Considering the size of the acquisition, the market might be skeptical about the ability of management to integrate RPC into its operations. Additionally, to finance the acquisition of RPC, the company issued notes which increased long-term debt to $11.3 billion, pushing the leverage ratio to approximately 6x at the end of fiscal ’19.
With that said, Berry ended its fiscal year ’20 (FY ends in September) on a solid note with fourth-quarter sales flat year-over-year and with EBITDA and adjusted EPS growing 18% and 77%, respectively. The integration and synergy realization of the RPC acquisition is progressing “better than planned”, and with the goal of reducing its leverage for fiscal 21′, management is on track to de-risk the business.
The discrepancy in valuations between Berry and its peer group is too large to ignore. The company trades at approximately a 50% discount to peers with the average forward earnings for the group at 15x. We believe the market would re-rate Berry at the sector average once the company de-risks its balance sheet and successfully integrates RPC. Until then, there is an opportunity to own a good business at an excellent price. We see an upside opportunity of approximately 40% from multiple expansion.
Quick Business Overview
Berry Global Group is the second-largest manufacturer, by market cap, of plastic consumer packaging, and engineering materials. With the acquisition of RPC, the company is on target to reach approximately $12 billion in sales, almost in-line with Amcor’s (AMCR) total revenues of $12.5 billion, which we believe is the biggest manufacturer of plastic packaging products.
Berry operates under 4 segments: Consumer Packaging International, Consumer Packaging North America, Engineered Materials, and Health, Hygiene & Specialties.
Under the Consumer Packaging segment, the company manufactures containers and lids, polypropylene cups and lids for hot and cold beverages, bottles, prescription vials, and a complete line of extruded and laminated tubes. End-markets include the food and beverage, personal care, household chemical, pharmaceutical, quick service restaurants, and the consumer and industrial packaging industries. The Consumer Packaging segment (International and North America) accounts for approximately 54% of net sales.
The company’s Engineered Materials, and Health, Hygiene & Specialties segments offer more specialized products, such as stretch and shrink films, tape products, PVC film, trash-can liners, retail bags, surgical drapes, cleaning wipes, and absorbent hygiene products. End-markets served are diverse ranging from food manufacturers to shipping and e-commerce, to personal care.
The Big Picture
Through acquisitions and organic growth, Berry has grown revenues from $4.6 billion in 2013 (when the company completed its IPO) to $11.7 billion in 2020, or a compounded growth rate of 14%.
Growth has been accretive to shareholders so far. For example, gross profit has grown from $812 million in 2013 to $2.4 billion in 2020, or a CAGR of 17%; while operating income grew from $400 million to $1.3 billion during the same period, for a CAGR of 18%.
This simple trend analysis shows that growth has been profitable for Berry and its shareholders. It also highlights the ability of management to successfully execute its acquisition strategy. As a result, EPS growth has compounded at an impressive 28% rate, growing from $0.83 in 2013 to $4.85 in 2020.
Gross and operating margins have been stable for the most part, averaging approximately 19% and 10% respectively. We believe the scale of Berry allows the company to benefit from economies of scale and the ability to pass through inflation costs to customers lowers the margin volatility:
Due to differences in the timing of passing through resin cost changes to our customers on escalator/de-escalator programs, segments are negatively impacted in the short term when plastic resin costs increase and are positively impacted in the short term when plastic resin costs decrease. – 2019 annual report
It is also important to note that approximately 70% of production goes to consumer end-markets which is non-discretionary by nature, giving the business some insulation from the economic cycle. At the end of 2019, no single customer represented more than 5% of total sales, while its top-10 customers represented approximately 20%.
Is Berry a good business? Using its return on retained earnings as a simple benchmark, we think so. From the time it IPO’d to the current fiscal year-end, the company has generated a total of $19.5 in EPS. Since the company doesn’t pay dividends, management retains 100% of the earnings. During the same period, Berry has grown EPS by $4, giving us a return on retained earnings of approximately 20%. We argue that for now, shareholders are better off if management continues to keep retaining 100% of the company’s earnings since they can get a high return on investment, therefore compounding shareholder value.
Solid year-end results
Berry ended its fourth-quarter and fiscal year on a solid note. Fourth-quarter sales were flat year-over-year at just over $3 billion with organic volume growth of 4%. Still, while revenues were flat during the quarter, EBITDA increased by 18% to $586 million driven by organic volume growth, cost productivity, and contributions from synergy realization. The company is slightly ahead of schedule with its planned cost savings from the RPC acquisition, which were 17% higher than expected for 2020. Berry expects approximately $150 million in synergy cost savings once management is done integrating RPC.
The company also ended the year with a strong free cash flow of $947 million, an increase of 24% compared to last year. Berry used its free cash flow and cash on hand to reduce its outstanding debt by $1 billion, ending the year with a leverage ratio of 4.3x compared to 4.8x at the beginning of the fiscal year. As a result of the debt repayment, interest expense is expected to be lower by $50 million.
Management gave guidance for fiscal ’21, calling for $2.15 billion to $2.2 billion in EBITDA and free cash flow in a range between $875 million and $975 million (including planned CAPEX of $650 million) driven by expected organic volume growth of 2%. The company still has as a number #1 priority, the strengthening of its balance sheet, guiding for a leverage ratio between 3.8x and 3.9x at the end of fiscal 21′, or approximately one turn lower. If the company achieves its EBITDA target, then we could be looking at approximately another $1 billion in debt repayment, lowering interest expense by $50 million again, which could be a boost of $0.37 in pre-tax EPS.
The Bottom Line
Given the low valuation of Berry, we believe the stock has the tools necessary to outperform the market in the upcoming year. At approximately a 50% discount to its peer group, market expectations are low. Once the company can show the market they succeeded in integrating RPC and achieved the targeted synergies, the street might be willing to pay more for Berry, re-rating them at a multiple at least comparable to its peers. If that is the case, Berry could trade 40% higher due to multiple expansion.
While management has created shareholder value via acquisitions and organic growth, there is the danger of chasing growth just to show consistency, which could lead to unfavorable acquisitions and destruction of shareholder capital. With the acquisition of RPC, Berry is now a company doing approximately $12 billion in run-rate revenues. We can’t expect the company to grow at double-digit rates anymore due to its size. Its closest competitor, Amcor, is also a $12 to $13 billion in sales company growing through acquisitions; the company’s reinvestment runway might be getting shorter which could lead to a hot M&A market in the sector and therefore overpaying for growth.
With that said, at just 9.7x forward earnings and 7x P/FCF, Berry is too cheap to ignore and we believe there is enough margin of safety to initiate a long position.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.