Jarring Discovery: Containers Are Hot

S&P has a positive outlook on the industry's growth due to lower fuel costs and market conditions, with cans stronger than plastics

From Standard & Poor's Equity Research

A recent addition to the is the S&P 1500 Containers Metal & Glass subindustry index. This index consists of four large- and small-cap companies, two of which—Ball Corp. (BLL) and Pactiv Corp.(PTV)—represent more than 75% of the market value of the index.

During 2005, this subindustry index fell 8.3%, vs. a 10.0% advance for the S&P 1500. So far this year, however, the group is up 9.9% compared with the market's 5.5% gain.

The relative strength chart () also looks positive. As a reminder, the jagged blue line represents the subindustry index's rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindustry index's 14-year mean relative strength.


  So now the question is "Is there any upside potential left?" Well, S&P equity analyst Stewart Scharf has a positive investment outlook for the group. He notes that fuel costs have declined and global market conditions appear favorable, which should allow unit shipments to pick up modestly. Scharf thinks most container companies will also be able to pass along higher costs for resin, steel, and other raw materials to customers. S&P's projected 2006 p-e multiple for the group is at a small discount to that of the S&P 1500.

Meanwhile, Scharf says that demand for beer has been declining in favor of wine and spirits on a global basis, and major can makers are converting the standard 12-oz. cans to 16-oz. and 24-oz. cans, which they believe will be more desirable. Beverage can and bottle sales should benefit from what has been a hot and dry summer in many regions of the U.S., as well as in parts of Europe. The analyst thinks improved production efficiencies and new products, such as easy-open closures on cans and a shift to larger cans, will gradually aid unit volume growth.

Scharf still expects plastic volume to remain relatively weak, however, despite a transition to more plastic bottles such as polyethylene terephthalate (PET), while near-term margins are squeezed by higher fuel costs, which affect resin prices for plastics. Container companies are focusing on emerging markets, such as China, Eastern Europe, Russia, and Latin America, many of which are still developing the use of disposable containers.


  Scharf also thinks a resolution (effective in May, 2006) to the mandatory beverage-can deposit law in Germany should gradually benefit results there as cans return to store shelves. Demand for beverage cans in Europe will continue to grow, in S&P's view, with industry shipments projected to advance in the mid- to high-single digits in 2006 and 2007. Some packaging companies plan to consolidate underperforming facilities in Europe as they focus on new product development.

One cautionary note: Scharf says that legislation that would prohibit, tax, or restrict the sale or use of certain types of containers, and would require diversion of waste such as packaging materials from disposal in landfills, may be introduced in the U.S., Canada, Europe, and Asia at some point in the future. If widely adopted, S&P thinks it would have a material adverse effect on the container industry.

So there you have it. The subindustry index's momentum and fundamental investment outlook point to the potential for above-market price appreciation in the period ahead. Of the companies mentioned in this article, both Ball and Pactiv are ranked 4 STARS (buy) by S&P.

Source: Standard & Poor's

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), along with a stock that has the highest S&P STARS (tie goes to the issue with the largest market value).

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