Good Things in Packaging
By Stewart Scharf
This week's S&P Focus Stock is Pactiv (PTV ), ranked 5 STARS by Standard & Poor's, its highest investment ranking.
Spun-off from Tenneco in 1999, Pactiv is a global supplier of specialty packaging and consumer products, a modest growth market. In spite of its modest growth profile, though, Pactiv's products hold the No. 1 or No. 2 market share position, as it focuses on market niches with strong growth opportunities offering attractive margins. Last year, Pactiv introduced 50 new products, which included value-added product line extensions.
S&P believes that Pactiv is well positioned to benefit from mid-single digit unit volume growth and improved profitability levels, as resin prices are expected to decline over the next few months. The majority of the company's volume gains should come from the consumer and food/foodservice packaging division, led by strong demand for the Hefty tableware and waste bags product line, and increased sales of meal replacement products.
Additionally, the restructuring of Pactiv's protective/flexible packaging segment, which will include plant closings, the exiting of low-margin products and staff cuts, should benefit results later this year, leading to 10% group operating margins within 18 months, more than double the recent level.
Revenues grew from $900 million in 1995 to over $3 billion in 2000, fueled principally by acquisitions, including the purchase of Mobil Plastics (Hefty product line). During early 2001, Pactiv sold its under-performing polyethylene packaging business for $71 million, and its remaining 6% equity interest in Packaging Corp. of America for $73 million. Proceeds from these sales are earmarked to reduce net debt to below $1.4 billion by 2001 year end from $1.55 billion a year earlier, and $2 billion at the end of 1999, reducing the debt-to-capital level below 45%, from 54% after the spin-off. S&P also expects Pactiv to continue to improve its working capital, as well as its inventory turnover and accounts receivable level.
We at S&P expect Pactiv to use more than $145 million in free cash flow generated during 2001 primarily for additional strategic acquisitions and debt reductions, as multiples are well below the seven times EBITDA that packaging companies were commanding just a few years ago. Capital expenditures are projected at $170 million for 2001, while depreciation and amortization should total about $180 million.
We expect a positive earnings trend to continue for the balance of 2001, and into 2002, with Pactiv emphasizing the growth of core businesses, cost reductions and niche acquisitions. Despite nearly 6% year to year sales decline in the first quarter of 2001, earnings were in line with consensus projections. Furthermore, excluding a 5% negative foreign currency impact and divested business lines, sales increased 2%. Gross margins widened 260 basis point to 29.6% in the period, while EBITDA margins expanded 120 basis points to 18%, as higher selling prices and cost controls offset an increase in raw material costs.
With high Hefty brand awareness setting the stage for further growth from this product line -- which holds the No. 1 market share position in several categories -- S&P anticipates further sequentially improvement in profitability levels and return on capital employed.
The shares, trading at a modest 14 times our $1.05 EPS estimate for 2001, represent an approximate 20% discount to the projected p-e of its closest peers, and an approximate 40% discount to the multiple for the S&P 500. We are projecting close to 15% EPS growth for 2002, as an economic rebound should further contribute to the expected recovery in the protective packaging area. Assuming that Pactiv will command a p-e multiple equal to its peers at nearly 18 times 2001 earnings, S&P believes that Pactiv has upside potential of 25% from its current quote.
Scharf is an equity analyst for Standard & Poor's