O-I Glass, Inc. (OI) surprised investors with some good news, as it sold its ANZ business in an effort to get more streamlined and importantly to reduce debt. This deal was welcomed by investors as shares rose nearly 10% upon announcement of the transaction albeit from lower levels, although the exact reaction of investors is hard to isolate, as the company furthermore updated on volume trends for the month of June.
Truth be told is that the company has been struggling for years, and with the exception of some temporary moves higher, shares are back to levels at which they traded in the 1990s, making it fair to say that the company is a serial underperformer plagued by continued restructuring efforts which have a real structural component and hence have real and serious impact on cash flow generation.
This is arguably the reason why investors no longer believe the management and its adjusted earnings metrics. While cheapness alone is attractive and the company seems to have made a nice sale of some non-core activities, it is far too early to conclude that restructuring has come to an end, as the sale is not enough to change the investment thesis.
The company has sold its ANZ (Australian & New Zealand) business to Visy Industries, a large, privately-owned packaging company. This deal and a sale-and-leaseback with property firm Charter Hall results in gross proceeds of 947 million Australian dollars.
The company aims to streamline operations and of course reduce debt as the move is welcomed by investors, as mentioned in the introduction of this article. The ANZ business generated 733 million Australian dollars in sales in 2019 on which 124 million Australian dollars in EBITDA were generated. This suggests that activities were sold for 1.3 times sales and 7.6 times EBITDA.
Given the fact that we are talking about Australian dollars here, we have to convert the amounts to USD with the transaction resulting in gross proceeds of $652 million and net proceeds around $620 million.
The transaction news was furthermore accompanied by a reasonably upbeat comment on the month of June. Shipment volumes dropped 18% over the period April-May yet volume trends improved to minus 3% in the month of June, which is quite comforting.
How Significant Is The Sale?
To answer the questions above, let’s go back to the 2019 results. The company reports its results across three segments based on geographic presence. The company reported total sales of $6.7 billion last year, down about 3%. North America is the most important segment with sales of $3.6 billion, followed by a $2.4 billion contribution from the activities in Europe. Asia-Pacific contributed $634 million in sales as the majority of this segment will be sold with roughly $500 million in revenues being divested now. Furthermore, it should be noted that segment margins came in around 13% for both North America and Europe. Lack of scale headwinds resulted in margins in Asia-Pacific stuck around 5%.
Net debt stood at $5.0 billion by year’s end of 2019, and while that excluded about $700 million in pension assets and equity investments, it also excluded little over a billion in pension and asset retirement liabilities. With a diluted share count of 155 million shares trading around $12 at the start of the year, equity merely represented $1.9 billion in value for a $7 billion enterprise value. This meant that all assets were valued around 1 time sales. Given the lackluster margins of the Asia-Pacific operations and thus the ANZ business as well, the price tag of the divestment of the ANZ activities sounds quite encouraging.
The earnings number last year were very complicated. The company reported a GAAP loss of $400 million, equal to $2.58 per share, and at the same time reported adjusted earnings of $2.24 per share, or $351 million in an actual dollar terms. The gap of $751 million is largely explained by a $595 million goodwill charge, which I am happy to adjust for, yet other costs related to transformation, restructuring and pension settlements are quite recurring and actually involve cash outflows (at least to a significant part).
Adjusted for the impairment charge, realistic earnings might more come in around $200 million, still sufficient for earnings around $1.30 per share, as the company guided for flattish adjusted earnings per share throughout 2020 which looked compelling, yet these were adjusted earnings and leverage ratios were very high of course.
With shares trading around $10 at the start of the year, they rose to $15 in February, fell to $5 during the Covid-19 peak, and now trade back at $10 again as volume trends have recovered and the company is bringing in some much-needed money at what appear to be reasonable terms. That said, sales will drop about 8% on a pro-forma basis as net debt will come down little over 10%.
The defensive nature of the shares has not played out. While food and drinks are an important end markets, spirits and beer is an even bigger market as these markets have been hit harder than the uplift seen in some other categories.
Reality is that while the recent move is welcomed, leverage is still a big issue as this is a capital-intensive industry with slim margins and long-term volume under pressure from alternatives such as aluminum cans and other applications. While management is trying to address leverage and deal with other environmental/pension liabilities, implicit leverage remains high, disappointments continue to arrive, and adjusted earnings do not paint a fair view of the realistic earnings power.
While shares look cheap and very well might be cheap, there are few triggers to create valuation multiple inflation, as continued restructuring seems the likely path. This conclusion seems valid even after what appears to be a nice sale, yet far from impressive enough to move the needle in a big way as cheapness alone simply does not do the job.
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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.