BERY - Berry Plastics Group

[manuelbean]

I think the two responses illustrate an interesting phenomenon that applies to Berry (and virtually all a lot of public real estate*)

 

To the private equity type, Berry is underlevered. 4x-5x is nothing in PE, below average (pre-covid at least). I looked at some deals in 2018/19 at 8-9x leverage with generous addbacks. I'm not saying that's correct and I think that some deals were just nucking futs, but just providing perspective.

 

To public equity types, Berry is scarily levered, because corporate publicly traded blue chip America is soooo much less levered than PE.

 

Berry throughout much of its public life has taken the PE approach, lever up, buy companies, which makes sense given its Apollo roots and may be rational, but its leverage prevents a re-rating and scares off traditional buyers of public equities, leaving the stock to wallow in perpetual value fund land owned by schmucks like me and you all.

 

But they've gotten religion and are telling folks they're going to de-lever even if it's not the best use of capital. In a perfect world, I'd have them run it like a buyout and do divvy recaps and size it for the risk. But in this world, I think their shift in thinking is fine. De-lever it all the way so that timid public market participants don't have to talk about the leverage so much.

 

*Example: See ALEX thread. I said it was low leverage because it was 30-45% LTV and 15% debt yield for low cap rate assets, first comment on it said "6x EBITDA seems high". See PGRE call yesterday where REIT analysts are all like "when are you going to de-lever from 8x and Albert was like "never bro". See SLG presentations and conference calls "we are less levered than private market and you all keep rattling on about leverage". Part of this is that EBITDA takes into account G&A and debt yield/LTV does not. G&A is a real expense so you need to look at both, I'm just pointing out the dichotomy.

 

Some key takeaway from Berry's quarterly earnings

 

1) Holycrap - Volume is up this past quarter.  We have people staying home and they are guiding to a 2% organic volume decrease in FY 2H 2020.  They confirmed $800mm of FCF.  Just wow!  65% of the business is staples, think food containers, medical wipes, drapes, etc.  Volume is actually up.  35% is more cyclical, auto, industrial, and institutional can liner (garbage bags).  Can liners historically have been non-cyclical, but most schools are closed. 

 

2) There is more evidence that once Berry acquires a company, their margin expansion is structural, not fleeting.  If you look at AEPI's EBITDA margin prior to the acquistion, it ranged from high single digits to low teens.  A few years after the deal, Berry still sports a 17-18% EBITDA margin in their engineered materials' division where AEPi makes up a big chunk of the EBITDA.  This is largely due to larger scale in purchasing both resin and other materials, being able to pass through resin price increases faster, and running leaner.  It is fascinating to see a company actually execute on a roll up and see how AEPI went from a "chunky" and lower margin business to much smoother and higher margin business inside of Berry.  Mind blowing! Don't get me wrong, I haven't made much money owning Berry.  It's been extremely frustrating to own in the last few years. But I think the market is starting to appreciate how unique of a business it is. 

 

3) Despite having no organic growth, Berry is actually a potential compounder.  A compounder's definition is that it earns a high return on capital and it can deploy capital and earn a high return as well.  What is counter intuitive is that Berry has no organic growth.  Okay maybe 1-2% organic.  It is obvious they earn a high return on capital.  $600mm of cap ex on a $2.1-2.2bn EBITDA business means cap ex is only 27-28% of EBITDA.  Note that this is a higher level than what they have run.  Management team is appeasing public equity holders.  I think the right way to run Berry is to run it with high return on capital which is to be okay with 1% organic volume decline.  But this is the public market and people get freaked out over 1% volume declines.  Well, they have new bosses and everyone thinks that Berry's management team is clownish. 

 

4) Shifting viewpoint - So they finally reported organic volume increases during this quarter after promising people that they will.  I get the sense that they are starting to guide more conservatively so that they can beat.  For example, they just lowered interest expense by about $25mm because LIBOR has dropped by 50bps.  I think the sentiment will change from "clown management team to wow wonderful business that only drops 2% volume in a sh$t show of an economic back drop".  Also, people appreciate a steady cashflow machine during a recession.

 

5) How does this go wrong?  I think if they somehow do worse than 2% organic volume decrease in 2H FY 2020.  This would require that supply chain or customers having issues such as plant closures etc. 

 

6) Timing - Should get to 4x debt/EBITDA in next 6 quarters.  FCF will likely be somewhere between $900-$1bn by then.  The bridge is $800mm in FY 2020, then another $75mm of synergy in 2021 and debt paydown of $1.3bn which should lead to $52mm of interest savings.  So $900mm after adjusting for 21% tax rate.  Historically, they tend to under promise on synergy and extract more.  FCF this year will likely be more than $800mm. 

 

7) Valuation - At 10x EV/EBITDA or a 12x P/FCF for a 4x EBITDA levered business, this implies $94 or $84 per share.  The key thing here is that Covid 19 has already punched this company in the mouth and they are projecting 2% volume decrease for 2H FY 2020 and then growing volume afterward.  I am not sure if you can ask for me in an investment.  Okay, okay, you can have a Saas company that still grew 20% during this period.  But  you are paying 7.2x FY 2020 FCF.

 

8) FY 2020 FCF yield of 13.8%

 

Hi there BG2008, 

Is P/FCF a good metric for such a leveraged company? Shouldn't we be looking at it on an EV/FCF basis (probably as a PE firm would look at it if it were to buy the whole company)? If so, the stock is trading at (give or take) 16x 2020FCF and 15x 2021FCF (I probably should be using unlevered FCF). Now, I don't know if this is cheap or not because I'm new to this space, but I don't feel it's an obvious bargain.

 

 

 

[BG2008]

Manuelbean,

 

EV/EBITDA is the best way to look at this company.  In a LBO, Berry will probably get taken private at 10x EV/EBITDA which would be roughly $22bn.  So the math implies about $10bn for the market cap which divided by 135mm shares is roughly $76.9 per share.  What's nice about Bery is that every year you own the stock, the debt gets paid down by $800mm in 2020, $900mm in 2021, and more each year.  Debt paydown reduce interest expenses which further increases FCF which further increases debt paydown.  At a constant 10x EBITDA multiple, more of the value shifts from the debt holder to the equity holder.  You should look at both metrics, EV/EBITDA and P/FCF.  Where you can do really well with levered companies (good business underneath) is to own buy into a low Market Cap/EBITDA multiple which in this case is about 2.5-2.6x.  The EB/EBITDA is a common metric for private equity acquisitions.  If you google Plastic packaging primers, there are plenty of literature on the industry by E&Y, William Blair, etc.  The lowest multiple that I have seen are 8x and higher multiples are over 13x.  Berry is very diversified and has a ton of structural scale advantage, so it should merit a high multiple.  In short EV/EBITDA and P/FCF should both be considered. 

 

The EV/FCF argument is a bit of a beginner argument.  EV/NOPAT is another valid argument.  But you can't use EV/FCF because then you are overly penalizing the company for interest expense.  A good way to think about Berry is that you're kind of buying a $1mm worth of real estate for about $700k and there is a roughly $500k of debt on it.  If you use the market debt to EV ratio, it looks like it is very levered.  But if you use the private market value of $1mm of value to calculate LTV, it is not as levered. 

 

ThePupil has also mentioned that in the private world, debt/EBITDA would be in the 6x to 7x range.  Because they don't need to report publicly, there will be no volatility in the share price.  Because Berry is a public company, there seems to a mantra that debt/EBITDA should be in the 1-2x range.  So in a way, Berry is an outlier by keeping debt between 4-5x.  This makes the market very uncomfortable. 

 

If you read some Michael Mauboussin on EV/EBITDA, it will help. 

[manuelbean]

Thank you for your explanation BG2008. I will read what you have recommended as soon as I can.

 

My problem with EV/EBITDA - and I know perfectly well that the world won't adapt to my views- is that different companies are able to turn that EBITDA into FCF at different rates. Shouldn't that count for something? Shouldn't the EV/EBITDA multiple be variable depending on the % of EBITDA that actually gets turned into FCF?

 

By the way, what if one uses EV/ Unlevered FCF? Would that be a better metric than P/FCF?

 

Thank you for your help

 

 

[BG2008]

Thank you for your explanation BG2008. I will read what you have recommended as soon as I can.

 

My problem with EV/EBITDA - and I know perfectly well that the world won't adapt to my views- is that different companies are able to turn that EBITDA into FCF at different rates. Shouldn't that count for something? Shouldn't the EV/EBITDA multiple be variable depending on the % of EBITDA that actually gets turned into FCF?

 

By the way, what if one uses EV/ Unlevered FCF? Would that be a better metric than P/FCF?

 

Thank you for your help

 

Self awareness there.  I think you should look into this. 

[manuelbean]

I'm sorry. I didn't understand your last post. Could you clarify please?

 

Thanks

[BG2008]

What I mean is that you should look into how the company converts EBITDA into FCF to the company and how much Cap ex they need to sustain the business.  I have explained it a bit on this thread.  But I suggest that you should dig into the 10-Ks and the company earnings a bit.  This is a company that will tell you what the FCF is at the beginning of the year and they have never miss a FCF guidance.  That should tell you something about the quality of the business when it is so "bond like"  More predictable cashflow means higher EBITDA, EBIT, FCF multiples blah blah blah

[Guest Schwab711]

They just paid 8x EBITDA on a control basis for a competitor. Why would anyone buy BERY for 10x?

[thepupil]

They just paid 8x EBITDA on a control basis for a competitor. Why would anyone buy BERY for 10x?

 

Mr. Market had paid 9.5-10X for BERY (and higher) throughout its history. Granted that’s using gurufocus, if I eyeball Bloomberg it’s more like 8x forward but has traded to 10x many times in its history.

 

https://www.gurufocus.com/term/ev2ebitda/BERY/EV-to-EBITDA/Berry-Global-Group-Inc

 

NYSE:BERY' s EV-to-EBITDA Range Over the Past 10 Years

Min: 7.9  Med: 10.4  Max: 14.5

Current: 9.33

 

10x $2B clean EBITDA a year out  doesn’t seem too wild of a stretch.

 

Also the concensus was that BERY got away with paying a less than full price by waiting til the last minute and taking advantage of British takeover law. Admittedly, though I heard this from funds that owned a lot of BERY so this was a self serving read of the situation.

 

The more negative read is that RPC was itself a levered roll-up with low earnings quality and possibly even some shenanigans. The 2017 writeup and comments on RPC on VIC provide some background. I think the VIC writeup on RPC is required reading for BERY observers/longs. 

 

Note that 3 years ago BERY and RPC traded for $18B separately, now they trade for $16B together with cheaper debt. Note that the median plastics companies traded for 10.5x EBITDA then too.thise datapoints illustrate the opportunity

 

But also important to recognize the negative rumors about RPC quality. Ultimately BERY is a levered roll up with lots of adjustment to earnings, so that impacts sizing.

 

https://www.valueinvestorsclub.com/idea/RPC_LN/1849370811

 

https://www.google.com/amp/s/nypost.com/2019/02/07/leon-blacks-apollo-outsmarted-by-former-company/amp/

 

 

 

[thepupil]

Mr. McGuire: I want to say one word to you. Just one word.

Benjamin: Yes, sir.

Mr. McGuire: Are you listening?

Benjamin: Yes, I am.

Mr. McGuire: Plastics.

Benjamin: Exactly how do you mean?

Mr. McGuire: There's a great future in plastics. Think about it. Will you think about it?

 

Despite this, U.S. demand for flexible packaging—most of which is plastic—is forecast to jump by 10% this year, compared with 3% last year, according to research firm Wood Mackenzie. In Europe, growth is estimated to hit over 5% compared with 1.5% last year.

 

https://www.wsj.com/articles/single-use-plastic-is-back-in-the-pandemic-era-11593432748?cx_testId=3&cx_testVariant=cx_5&cx_artPos=4#cxrecs_s

[thepupil]

Berry redeeming its highest coupon debt @ par. Combined with their redemption of the 5.5% on July 23rd, this equals $350mm of debt reduction in July at 5.5-6.0%. ~$20mm of annualized interest savings. About 3% of their debt, but a higher percent of their interest expense.

 

it looks like the other "high" cost bonds (defined here as >5%) need a little more time to be open @ par. For example the $500mm 5 5/8% of 2027 aren't open at par until 7/2024 and @ 102 7/8 @ 7/2022.

 

they could still tender/exchange at a premium of course.

 

 

 

On July 1, 2020, Berry Global, Inc. (“BGI”), a wholly owned subsidiary of Berry Global Group, Inc. (the “Company”), elected to redeem in full

the $200 million aggregate principal amount remaining outstanding of its 6.00% Second Priority Senior Secured Notes due 2022 (the “Notes”) in accordance with the terms of the indenture governing the Notes. As specified in the Notice provided to the holders of the Notes, the Notes are called for redemption on July 31, 2020 (the “Redemption Date”). The redemption price for the Notes shall be equal to 100% of the aggregate principal amount thereof, plus accrued and unpaid interest, if any, to the Redemption Date. BGI intends to fund the redemption amount with cash on hand.

 

 

 

[BG2008]

May 5th $250mm @ 5.5% = $13.75mm

May 22nd $100mm @5.5% = $5.5mm

June 23rd $150mm @5.5% = $8.25mm

July 1st $200mm @6.0% = $12mm

 

$39.5mm of interest expense savings on $700mm of debt pay down. 

[manuelbean]

Hey guys, shouldn't scale help Berry (and others) get better margins? I was just looking at its presentation and it seems that EBITDA margins have been going down for the past 3 years or so. What am I missing?

 

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[BG2008]

Resin input is volatile and largely tied to nat gas prices.  2016 was a year when nat gas prices were low due to O&G crisis which lowers resin prices.  This shows up as artificial higher EBITDA and gross margin.  Nat gas prices are higher in 17,18, 19, and then started trending lower in 19 and 20.  March 2020 shows an 18% EBITDA margin.  There were some company specific mis steps in 2019 which saw the company lose some customers.  The market interprets the mis steps as structural.  They are now gaining back the customers. 

 

It is important to focus on gross and EBITDA margin dollars per pound rather than overall margin %.  This is fairly common when you deal with volatile input prices. To be fair, some of the acquisitions has faced issues in the last couple years.  But the absolute valuation (in the context of a packaging as a bondlike instrument) is at a very low multiple. 

[BG2008]

Historical nat gas prices https://www.eia.gov/dnav/ng/hist/rngwhhdM.htm

 

[BG2008]

The mechanics is that higher nat gas prices means higher resin price which results in higher pass through price.  But Berry makes a constant $0.20 per lb of product whether resin is $0.50 or $0.90.  In a $0.90 resin price environment, the EBITDA margin would appear lower.  In a $0.50 resin price market, the EBITDA margin would appear higher.  But Berry makes a constant $0.20.  These dynamics are fairly consistent in special chemical or packaging companies where they have the ability to make a consistent X $ per lb of product sold.  But the margin can go up and down with the feedstock price. 

[manuelbean]

Thank you very much for the excellent explanation. I knew I was missing something  ;D

 

Some things I would like to better understand from your answers:

 

1. "There were some company specific mis steps in 2019 which saw the company lose some customers" Any links or keywords I can search?

2. "some of the acquisitions has faced issues in the last couple years". Any links?

3. "But the absolute valuation (in the context of a packaging as a bondlike instrument) is at a very low multiple.". Are you referring to Bery's valuation?

4. Where can I find those $0,20 per pound? I can't find it in the Annual Report. I was trying to find the number of pounds that the company has bought (or sold) but with no success.

5. I know nothing about natural gas prices. Are they expected to go up or down? 

 

[BG2008]

Thank you very much for the excellent explanation. I knew I was missing something  ;D

 

Some things I would like to better understand from your answers:

 

1. "There were some company specific mis steps in 2019 which saw the company lose some customers" Any links or keywords I can search?

2. "some of the acquisitions has faced issues in the last couple years". Any links?

3. "But the absolute valuation (in the context of a packaging as a bondlike instrument) is at a very low multiple.". Are you referring to Bery's valuation?

4. Where can I find those $0,20 per pound? I can't find it in the Annual Report. I was trying to find the number of pounds that the company has bought (or sold) but with no success.

5. I know nothing about natural gas prices. Are they expected to go up or down?

 

1. Do your own work, earnings calls

2. Do your own work, earnings calls

3. Yes

4. This isn't exactly the actual figure, it's for illustrative purposes.  Do your own work

5. Who the heck knows. But they can pass the price increases through very fast unlike the smaller guys who tend to get squeeze.  This is also why scale gives you advantage.  Do you own work to confirm this.  Look at time lag margins of Berry vs smaller players when nat gas/Resin gets volatile. 

[manuelbean]

Thank you very much BG 2008. I will keep on my DD with your guidance.

 

Now, thinking out loud just in case someone wants to comment  ::)

 

The management's variable compensation is tied to Adjusted EBITDA (75%) and FCF (25%). Although the Proxy states that this aligns the interest of the management with shareholders' interest, I don't think so. They would just need to halt spending or acquire a new company in order to make some more millions for themselves.

 

Add to this the fact (and I might be very wrong here) that some directors (connected to Apollo) didn't even know that the management was outbidding them for RPC. Isn't the role of the Board of Directors to make the capital allocation decisions? How could they have not known? Add to this the fact that the Chairman is also the CEO which, although frequent, obviously constitutes a conflict of interest.

https://nypost.com/2019/02/07/leon-blacks-apollo-outsmarted-by-former-company/

[manuelbean]

Any idea where the folks over at William Blair get these numbers? They are totally off.

 

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[BG2008]

The EBITDA isn't $2.3bn.  But it's probably @2.15 to $2.2bn on a run rate basis taking into account the RPC acquisition.

[manuelbean]

Neither is the revenue $13B  :-\

[manuelbean]

I've just read this.

 

"It is interesting to observe that between 2012-LTM 2019 Q2, acquisitions totaled $4.4B compared to FCF growth of (682-167)= $515. In other words, Berry spent $4.4B in debt infused acquisitions for an additional $515 of FCF, a 11.7% yield on their investments.

 

However, if we include their last acquisition of $6.5B and estimated FCF of $800M, the yield falls to (800-167)/10,900=6%! That is just 1-year post synergy, but let’s say the FCF increases to $900M, the yield is still just 6.7%! This just shows the dilutive impact of their latest acquisition vs historical record."

 

He's got a point there. Even if it goes up to $1B, the return on the acquisitions is 8%.

 

Am I missing something?

[thepupil]

I'm sympathetic to the general sentiment that the RPC acquisition remains a question. it was large, aggressive and a roll-up of another roll-up that had some questions lingering.

 

But I'm not sure if I really follow the overall line of thought. Using Bloomberg, free cash flow in 2011 was $167mm and $250mm in 2012, share count was 84-86 million, EBITDA margin was 13-14%, sales $4.5-$4.7b

 

I now see share count at 134 million, free cash flow at $800-$900 million, sales at $11.5B, EBITDA margin 16-17%.

 

So share count went up 57%, free cash flow went up by 3-5.5x depending on which number/year you use, margins expanded significantly, and sales went up by 2.5x. And that all occured while BERY de-levered from 6-7x levered to ($4.4-$4.6B of debt / $600-$700mm EBITDA) to 5x on its way to <4x and became the largest/2nd largest buyer of resin in the world.

 

why is that a problem?

 

so I guess I would agree that RPC is a question mark, but I don't really follow the whole "they only bought at 7-11% yield on investments" argument (this seems to include debt, but not add back interest, right?). BERY has very cheap and decreasing cost of debt. Some of the RPC debt is at 1-1.5% and the acquisitions appear to have been sustainably capitalized (and BERY is proving that out through de-leveraging aggressively.

 

overall, manuel, I share some of your hesitations with respect to BERY; it's not 100% clean, it's a roll-up, it has debt levels that some people find uncomfortable and is therefore a volatile stock. they just made a very big acquisition. but i think the debt load is very sustainable and therefore look at their record on a per share/levered basis and think it's super impressive. I would be bigger if it were a cleaner story and not percieved to be as levered as it is, but I doubt it would trade a teens fcf yield if that were the case.

 

 

[dwy000]

Also, FCF is AFTER debt service payments.  So if the acquisitions were paid using debt the increase is FCF us entity accretive to equity returns.

[dwy000]

Sorry, that should say " is entirely accretive to equity".  Fat fingers.