Change has been constant for Berry Global Group. It’s changed its growth strategy, its capital structure, even its name. What it can’t change is what it does: make plastics. While that’s contributed to its underperformance recently, it also created a buying opportunity for investors.
Things haven’t been easy for the $9.1 billion market-cap plastic-packaging maker. Acquisition debt and strategic changes hurt the share price despite earnings growth. And its major product has fallen from favor. The fact that Berry (ticker: BERY) makes plastic containers hangs over the stock like a plastic bag on an ocean reef. But writing off Berry for plastics overlooks changing practices in the industry and ignores one of the sturdiest of materials stocks.
Berry Global was taken public by Apollo Global Management (APO) in 2012. The company was saddled with debt—10 times earnings before interest, taxes, depreciation, and amortization, or Ebitda—then picked up more in a dozen deals designed to spur growth. Using takeovers to boost growth made organic growth look weaker by comparison; in 2019’s fiscal fourth quarter (ended in September), sales grew 47% year over year as Berry digested a large acquisition. Comparable volumes, however, fell.
Berry management recognized that things needed to change, so it started reducing debt and focusing on organic growth. Currently, Berry has $8.9 billion debt, net of cash, and has generated $2.3 billion in Ebitda over the past 12 months, for a debt to Ebitda ratio of 3.9 times. It also has committed to operating between three and four times debt to Ebitda, which isn’t far off packaging peers Sealed Air (SEE) and Amcor (AMCR). Organic unit volume growth—the kind that comes from existing businesses, not acquisitions—was up 5% during its most recent quarter, its sixth consecutive quarter of growth, and is expected to come in at 5% in 2021 from 2% in 2020.
Berry hasn’t been rewarded for these changes. During its most recent quarter, the company reported a profit of $1.53 a share, up slightly year over year, and better than Wall Street projected, despite higher raw material costs, on sales of $3.7 billion, up 26% from the same period in 2020. But its stock fell 1.1%. It now trades at just 10 times estimated 2022 earnings, down from a peak of about 18 times in early 2015, and well below the S&P 500’s 20.
That may be because of changing perceptions around plastic. Single-use plastic products have been hit by a consumer backlash. After spending the past decade making plastic lighter so less was used, it’s now working to make it easier to recycle, much like aluminum cans. “Plastic is an engineered product,” says Baird analyst Ghansham Panjabi, who has a Ph.D. in chemical engineering. “By definition, it can be re-engineered.”
CEO Tom Salmon says Berry can make plastic products out of recycled plastic, conventional plastic made from fossil fuels, or plastic made from sustainable feedstocks like algae or wood chips. It doesn’t matter what it’s made out of, he says.
For Berry’s stock to work, it will have to alter perceptions of both its business and the industry. Berry is expected to grow earnings at a 9% clip over the next three years, better than Amcor’s 5.5% expected growth and slightly lower than Sealed Air’s 10.5%. By reducing debt and perhaps paying a dividend like its rivals, Berry could narrow the gap between its 10 times 12-month forward earnings and Sealed Air’s and Amcor’s 15 times, which would imply a 50% gain on multiple expansion alone.
Berry doesn’t have to reach those heights for the stock to work. Its valuation is low enough that the stock should grow in line with earnings, or some 9% a year, without a change in multiple. That’s the minimum return investors should have for Berry shares.
Panjabi thinks it can do better than that. He has an Outperform rating and an $83 price target on the shares, up 23% from Wednesday close of $67.32. Panjanbi arrived at his price target by applying an eight times multiple to fiscal 2022 estimated Ebitda of $2.38 billion, slightly higher than the Street consensus of $2.32 billion, while pointing out that peers are trading at 10.5 times estimated 2022 Ebitda.
It is possible that perceptions of plastic can change, particularly relative to other packaging materials. “Right now, people look at [packaging] saying aluminum good, plastic bad,” says Panjabi. “Plastic packaging five years from now is going to look different than what it was five years ago.”
Write to Al Root at email@example.com