Idea courtesy of friends Michael Huang, Albert Li, and Marissa Hao
Berry Global group is a leader in the plastic packaging industry with a broad product portfolio diversified across 4 verticals: consumer packaging in both international and domestic markets, health/hygiene/specialty products including nonwoven specialty materials, and engineering materials like tapes and films. BERY is the number two global player in the packaging market but trades at a relative discount to its peers because of concerns over the liquidity and debt issues.
While BERY has typically grown through acquisition, they are now focused on organic growth, reducing leverage, and returning capital to shareholders. Concerns over margins and the future of plastics are overblown. With an activist investor on board and trading at a Free Cash Flow(FCF) yield1 of 10+%, BERY has the characteristics of a typical value play in a growth enamored market.
The Business
Though BERY has a lot of moving pieces with operations in many different areas, the business model is fairly simple. They buy resin from producers, create plastic products with that resin and sell it to customers who go on to use the products. BERY can also source resin through recycling plastics and have committed to increasing recycling capabilities over time through partnerships (Example 1, Example 2). They have typically grown through acquisitions thus increasing their Net Debt to > 5x adjusted EBITDA, before reducing it to 4.1x in the most recent earnings report.
BERY generates nearly $1B in Free Cash Flow each year and plans to use it to reduce debt to a reasonable level and return capital through buybacks. Their revenue and free cash flow growth over the past few years have been high (>15%), but fueled inorganically. After laying the roadwork, they should be able to reap the rewards as they print cash like The Fed. They have committed to organic growth over the coming years and should grow at the pace of the plastics industry which is ~3% a year. Some may worry about the plastic industry as a whole and the possibility of resin price inflation cutting margins, but both worries are overblown (discussed later). Even though the BERY team has a stable, cash-generating, business, it is materially underpriced compared to other companies in the packaging space. This underpricing is where the activist, Canyon Partners, comes in.
Canyon Partners' activist letter
In February of 2020, before the world fell apart because of one spiky boi, Canyon Capital Advisor wrote an activist letter to BERY management to do three things: hire someone to help deleverage, deleverage to the point where BERY becomes investment grade (ceasing M&A in the process) and correcting market misperceptions about ESG concerns. If you haven't noticed, they want to deleverage the company. Canyon compares BERY to its closest Competitor Amcor which the market offers premium valuations due to a better capital structure (< 4x Net Debt to Ebitda). Other plastic packaging companies also trade at a premium. Even at 4x Net Debt/EBITDA, Altium packaging, a comparable plastics manufacturer was assigned a 10x EBITDA Multiple when acquired. BERY currently trades at ~8x EBITDA. In addition to pointing out the relative undervaluation and horrid capital structure, Canyon also makes evident the importance of the right messaging on plastic production, recycling, and sustainability concerns. BERY is taking steps to reach sustainability goals as mentioned before and in reality, plastics are useful and likely not going anywhere. Management should make these points abundantly clear so people aren't turned off by the thought of investing in an unsustainable, non-ESG plastics company.
Worries over Plastic
The biggest concern people often have is with the plastic industry as a whole. Plastics are facing bans and John Oliver may paint a picture about the unsustainability of plastics, but alternatives are scarce. In addition, many plastics can be useful for increasing shelf life and curbing emissions.
A recent SPAC, Danimer Scientific, has garnered attention for its biodegradable plastics and the possibility of revolutionizing the plastics industry. However, claims made by the company have been dubbed "sensational.. exaggerated and misleading, according to several experts on biodegradable plastics". In addition, BERY's products are sold into many more markets than single use plastic bags and straws. The long term future of plastics may be uncertain, but plastics are an integral part of a growing global economy as more countries aim to modernize. Last time I checked, diapers weren't removing plastic. "What I've learned is the technologists are almost always right about the end state, but the frictions between here and there are often way greater." -Modest Proposal on Invest Like the Best. In my opinion, the pace of revolution in plastics is exaggerated, a perfect place for a value investor.
Resin Prices Concerns.
Another oft-raised surface concern is inflation in resin prices which constitutes 50% of BERY's costs. However, 70% of BERY's contracts pass resin prices to the customer, thus margins have held constant with fluctuating resin prices.
Valuation
The investment case is quite simple, but we can put some numbers to the valuation. A DCF is too detailed for a company with terminal value risk in the form of uncertainty in the long-term future of plastic, and the thesis resides on a re-rating of the multiple. We can model it out using other packaging manufacturers as follows:
The Canyon Partners letter also has a table with comparable companies and their valuations when acquired:
At a current multiple of 8.6x and a progressing deleveraging plan, there is downside protection. If it trades at a reasonable multiple of 10x EBITDA, there is 40% upside to the stock.
Flows Over Pros
Ultimately, a stock price comes down to who is buying and who is selling. h/t to Dan Mcmurtrie on the Business Brew Podcast for this framework. The holders of BERY are primarily institutions with the public owning less than 1% of the shares outstanding. Ultimately this stock will move with institutional buying: stock market promoters aren't going to promote a highly levered packaging producer for retail buying. However, a notable thing about BERY are possible catalysts for more ownership on the horizon: reframing ESG and reducing leverage. On the first point, if BERY is able to effectively rebrand, previously ESG focused strategies could start buying the stock. The latter point is more salient as many funds won't buy a company at > 4x Net debt to EBITDA. If BERY can hit their leverage goals, more money should be on the way. Ultimately, BERY stock will likely have more buyers than sellers in the coming year. As Tracy Alloway likes to say "Flows over Pros" and the flows are coming.
Risks
The primary risks are terminal value risk In the form of plastic bans around the world and a failed deleveraging. However, as discussed before, these risks are unlikely to manifest. In addition, any inflation in resin prices are passed through so margins remain consistent. Their news release page is a slew of releases about reducing the high cost debt and either refinancing it or reducing it. At an expected 1B FCF in 2021, it trades at > 10% FCF, which is unreasonably high for a company that is stable and growing at ~rate of population growth.
Conclusion
BERY may not be a sexy growth stock lighting the world on fire, but it has something many fintwit favorites don't: a metric ton of cash generation. Combining that with an activist campaign looking to unlock value, and catalysts for more flows into the stock, and a material mispricing, makes me bullish. It trades near the bottom of comparable company acquisition EBITDA multiples and public company valuations, thus providing a floor for the stock price and great risk-reward.
FCF yield is = Free cash flow/Market Cap