BLL & CCK – Can Makers Not Cheap

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SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

September 10th, 2014

  • BLL & CCK – Can Makers Not Cheap
  • Valuations for Ball Corporation (BLL) and Crown Holdings (CCK) are expensive on several metrics including forward price/earnings, forward EV/EBITDA and our own return on capital driven models. Of the two, BLL looks significantly more stretched – Exhibit 1.
  • The companies have overlapping interests in many markets and regions, but CCK has more of a focus on growth markets. In the press release announcing its recent acquisition of Heineken’s Mexican packaging division (EMPAQUE), Crown noted over 50% of beverage can revenue will come from developing regions post-integration. BLL is tied more to the flattish North American market but has greater exposure there to the stronger beer segment versus the declining soft drink category – 55% beer:45% soft drinks for BLL versus roughly 20% beer:80% soft drinks at CCK (though the EMPAQUE acquisition will bring this ratio more into balance).
  • With EMPAQUE, CCK will look a bit more like BLL than it did before. Previously, roughly 50% of CCK’s sales were tied to beverage cans, compared to 71% for BLL; Crown is levered more to food cans, and has a much less US-focused sales profile (74% of sales outside the US versus 60% within the US for Ball). This includes a roughly 10% sales exposure to the Middle East, where CCK management has indicated operations have been disrupted by the several ongoing conflicts in that region.
  • This is the second acquisition of $1B+ for CCK in the past year, the company having acquired Mivisa, a leading European food can manufacturer, in October 2013. The dual acquisition integration risk and the uncertainty surrounding the Middle East are the two obvious concerns for CCK. BLL has been a steadier option despite lower consensus growth estimates and has indicated a near term commitment to dividends and share repurchases; the loss of “a major food can customer” will be a headwind in 2015 however, and the stock is trading near the top end of its historical valuation ranges.
  • Given the uncertainty surrounding Crown, we think it is more likely that Ball’s relative multiple moves down to normalize versus Crown rather than CCK catching up to BLL’s current levels. The pairs trade looks more interesting than a naked long position in CCK today.

Exhibit 1

Source: Capital IQ, Bloomberg, SSR Analysis

Overview and Valuation

Ball Corporation (BLL) and Crown Holdings (CCK) are global leaders in metal can manufacturing, with overlapping interests in multiple markets and stocks that tend to trade in tandem – Exhibits 2 and 3.

Exhibit 2

Source: Capital IQ, SSR Analysis

Exhibit 3

Source: Capital IQ, SSR Analysis

Our return on capital based models work best for companies with long histories and clear trends, capturing multiple cycles. The numerous portfolios changes over the years at BLL and CCK and the clear step change in returns that took place in the early 2000s leave us with a somewhat abbreviated data set that shows valuations for both stocks have been well supported in the aftermath of the financial crisis – perhaps not surprising given the defensive nature of the industry (major end markets are beverages & food products).

Exhibit 4

Source: Capital IQ, SSR Analysis

Exhibit 5

Source: Capital IQ, SSR Analysis

Exhibit 6

Source: Capital IQ, SSR Analysis

Exhibit 7

Source: Capital IQ, SSR Analysis

Conventional forward valuation multiples confirm our ROC analysis, with both companies above their historical norms and BLL well ahead of CCK. Note that on a forward P/E basis, as on our own valuation model, BLL is at or approaching its historical resistance point, while its EV/EBITDA multiple is in uncharted territory, making it increasingly difficult to justify much further expansion. In 2015 BLL should also face a headwind from the loss of “a major food can customer” (ConAgra) that has switched suppliers – while the company has had ample time to prepare for this loss (by finding sales to make up the loss and/or taking cost cutting measures), it nonetheless presents a risk for a stock that is trading at elevated levels.

Exhibit 8

Source: Bloomberg

Exhibit 9

Source: Bloomberg

Exhibit 10

Source: Capital IQ, SSR Analysis

Exhibit 11

Source: Capital IQ, SSR Analysis

There are several factors explaining why BLL is currently trading ahead of CCK, despite having lower consensus growth estimates. All told we think there is a greater likelihood that BLL trades down to normalize versus CCK rather than CCK catching up to BLL. We should note that both would be particularly sensitive to lower than expected levels of economic growth and consumer spending.

Exhibit 12

Source: Capital IQ, SSR Analysis

Instability in the Middle East

CCK’s exposure to growth markets is a boon when the developing regions are stable and an albatross when they are not – as in the Middle East currently. In the Q2 earnings call, management noted that activity has been disrupted by the several ongoing conflicts there and they are concerned for the balance of the year. It was noted that the Middle East accounts for 35-40% of the European Beverage segment, which is 20% of CCK’s net sales, putting the overall exposure around 8% (not including any food can business in the region).

Exhibit 13

Source: Capital IQ

Inconsistency and Investment Approach

Exhibit 14 shows the quarterly EPS surprises for BLL and CCK since 2012. BLL has a better recent history of beating consensus, helped by some very strong beats over the past year, during which time the trend is particularly in BLL’s favor.

Exhibit 14

Source: Capital IQ, SSR Analysis

BLL seems to be much more cautious as a company and in their approach to capital investment – consistent with their superior self-estimation. Their recently announced expansion into Myanmar, for instance, was only considered because of supply agreements with KO – the volumes are essentially guaranteed. CCK’s approach is more to invest in capacity first and worry about volumes catching up later – they did this in China, Brazil, and the Middle East:

“We could have had the same conversation on a regional basis 15, 16 years ago in the Middle East when we were adding capacity. Initially, return on invested capital in the Middle East declined. We were building new plants. As you fill up a beverage can plant it takes you about 2 to 3 years to be running as well in your new plants as you are in your mature plants. Then as you add additional lines in the new plants, at times, you’ll have downturn in productivity and you came back up to over – you’re absorbing overhead extremely well and throwing off a tremendous amount of cash. We could have then moved on and had the same conversation about Brazil. We started out in Brazil somewhat early with a fairly large plant…first couple of years were a little bit tough. It took us a while to fill it up, took us a little while to run better. We now have 3 big plants in Brazil. We are the lowest-cost producer in Brazil. We’re gaining share in Brazil. Now we can move over to China and Southeast Asia – we could have this conversation every single time. So it’s all about your conviction as to whether or not you’ve picked the right growth markets.”

-Crown Holdings CEO John W. Conway

A case could be made that if CCK has indeed picked the right growth markets and results begin to come in over consensus in excess of BLL’s, this could be enough to close the gap. Given the uncertainty in the Middle East and the lack of historical precedent, this is hard to expect with any real conviction and CCK will have to demonstrate this ability before they get credit for it.

Notable Company Differences

Return on Assets

From an operational perspective CCK appears to have an edge, notably in the European Beverage market.

Exhibit 15

Source: Capital IQ, SSR Analysis

Geographic Exposure

The most obvious difference between the two companies is their geographical exposures, as shown previously in Exhibit 13. While their market shares in many regions are similar, on the whole CCK generates 74% of sales outside the US, while BLL generates 60% of sales within the US. This will change slightly with CCK’s recent acquisition of Heineken’s Mexican packaging operations.

Current Strategic Direction

BLL and CCK seem to be in different strategic modes at the moment – CCK has made two $1B+ acquisitions over the past year, while BLL has called off M&A for the time being, focusing instead on dividends and share repurchases. CCK pays no dividend and while it does have a history of repurchasing stock, BLL has shown more of a commitment in this respect, both in absolute terms and as a percentage of market cap. Note that Exhibit 16 below does not take into account CCK’s recent $1.2 billion purchase of EMPAQUE. So CCK potentially has quite a bit of acquisition integration risk. The $1.6 billion Mivisa acquisition, announced in October 2013 and closed this past April, appears relatively low risk as Crown is leaving the existing operations intact with only a few reallocations of assets and personnel. Mivisa is a food can maker with sales primarily in Europe.

Exhibit 16

Source: Capital IQ, SSR Analysis

Sales Mix

Metal can manufacturing as a business is very sensitive to small swings in volume. In the massive but stagnant North American beverage can market (see
Overview of Current Industry Dynamics
section for more detail), CCK is proportionally more exposed to the declining soft drink trend and less levered to the stronger beer market than competitor BLL. The EMPAQUE acquisition should bring CCK’s mix more into balance.

Growth Expectations

Crown’s greater overall exposure to Europe (versus BLL’s larger exposure to the flattish North American market) has the company better positioned to gain from a recovery on the continent. Brazil also slants in CCK’s favor, as Ball’s exposure there is in the form of a 60% owned JV. Despite the company’s recent troubles in the Middle East, that market is still a long term growth opportunity. Consensus confirms the superior growth prospects for CCK – Exhibits 17 and 18. There is greater belief however that BLL will be more effective at generating cash, likely due to CCK’s current acquisitive activity – Exhibit 19.

Exhibit 17

Source: Capital IQ, SSR Analysis

Exhibit 18

Source: Capital IQ, SSR Analysis

Exhibit 19

Source: Capital IQ, SSR Analysis


Overview of Current Industry Dynamics

Global Beverage Can Industry Market Shares

The global beverage can industry is highly concentrated. With the EMPAQUE acquisition, CCK will overtake Rexam for the #2 spot in North America.

Exhibit 20

Source: Company Presentations

Input Cost Pressures

Due to contractual differences, BLL and CCK can’t pass on aluminum price increases in Europe like they are able to in N. America and (to some extent) the Middle East. As aluminum has gained through the year, higher European aluminum premiums have weighed on the cost side.

End Markets – Products & Geographies

Can shipments are about 75% weighted to beverage markets, with the remainder going to food.

71% of BLL’s revenue is tied to beverage cans. For CCK this figure is closer to 50% and likely to increase with the EMPQAUE acquisition.

From beverages, the typical stratification is alcoholic (beer) and non-alcoholic (carbonated soft drinks, CSDs). While the North American market for beverage cans is 37% beer and 63% CSD, BLL is levered more towards beer (55%) than soft drinks (45%) – beer has held up better than CSDs where volumes have been flat to down in North America. The growing craft beer movement has been a pocket of strength. CCK on the other hand is more heavily slanted toward non-alcoholic beverages, and beer constitutes only 20% of their North American beverage can mix (again, EMPAQUE will help balance this ratio).

Long term, most particularly in the US, you need to be thinking about specialty packaging, i.e. the Coors Light can that turns blue when your beer is as cold as the Rockies. The days of the 12 ounce can are over, and as a percentage of can shipments the standard Coke can is on the decline – Exhibit 18. 12 ounce cans made up 94% of all can shipments in 2001. This fell to 88% by 2007 and then to 80% by 2013 – Exhibit 19. From 2007 to 2013, specialty non-12 ounce cans grew at an average annual rate of 7.4%, while 12 ounce shipments declined by 2.6% per year. The growth in specialty has not been enough to compensate for the decline in 12 ounce, and it appears that can volumes, stagnant since the late 1990s, faded in the aftermath of the Great Recession, ever as consumer spending surpassed pre-2007 levels (and had actually done so by October 2010). Pin this on changing consumer tastes (switch to Vitamin Water, Gatorade, et al, all of which are packaged in PET bottles) and increased health consciousness (weighing on soda volumes) among possible additional factors.

Other areas of the world still see growing can volumes – 90% of the beer in China for instance is still bottled using glass, but the trend is in the favor of can manufacturers. In Brazil just this year, in the months preceding the World Cup, beer shipments in cans surpassed beer shipments in glass for the first time. Eastern Europe also remains a far from developed market and volumes have been strong in that region.

The market in China is dealing with overcapacity which is weighing on pricing power. The sheer size of the market and the scale that large multinationals like BLL and CCK can provide make the region profitable nonetheless. It seems like the companies’ current plan is to continue business as usual while waiting for the consistently growing demand to soak up the excess capacity.

In Brazil both CCK and BLL have been adding beverage can capacity, partly to accommodate increased World Cup demand. BLL added a new line at an existing plant and CCK added an entire new can factory.

SLGN is the major player in metal food containers in the US with a market share of 54%. BLL has a 17% share, and CCK is next with 15%. In the European food container market, BLL is a minor player while CCK post the Mivisa acquisition will hold a leading market share of 36% – the next closest competitor is Ardagh with 24% before a smattering of smaller players with the remaining 40%.

Cans for food products are predictably dependent on agricultural harvests, representing another tie-in to other areas of our coverage (aluminum pricing, consumer spending). On the surface, CCK’s acquisition of European food can manufacturer Mivisa is questionable, given that 43% of that business’s sales are in Spain – but Spain is second only to Italy in European exports of canned food products. Additionally, in Europe food cans are of a more premium quality than what comes to mind domestically (Spam?) and are therefore a much more viable product than in the US.

Another area where BLL and CCK compete is in aerosol cans – in the US BLL has a 28% share of the market, with CCK next at 26%. BLL has recently made acquisitions in this area, acquiring facilities that have given it a commanding 89% share of the aluminum slugs that are the main input in the production of aerosol cans. This market is a much smaller part of the revenue mix for these companies, but it is a tangential business that has a slightly higher growth rate than traditional cans (or as the company states delicately in their 10-k, “is growing faster than other parts of our business”).

Exhibit 21

Source: Capital IQ, SSR Analysis

Exhibit 22

Source: Capital IQ, SSR Analysis

Exhibit 23

Source: Bloomberg

Exhibit 24

Source: Bloomberg

Exhibit 25

Source: Bloomberg

Exhibit 26

Source: Bloomberg

Exhibit 27

Company Segments

As a percentage of sales, BLL slants slightly more toward beverages and CCK towards food. But there is not much of a margin spread between those two markets and this seems like more of a regionally driven business – for instance cans have caught on in Brazil and have taken market share from glass so margins have been higher, while in North America the market is more mature and spending on cans has stagnated.. BLL has an aerospace segment that is 10% of sales with little to no integration with its packaging operations – on the surface, 94% of segment sales tied to the federal government shouldn’t be a multiple enhancer. The potential margins are decent but the project flow isn’t steady and this has been BLL’s lowest returning segment since 2011. Crown has a Non-Reportable segment that encompasses aerosol cans and specialty packaging operations.

Exhibit 28

Source: Capital IQ, SSR Analysis

Exhibit 29

Source: Capital IQ, SSR Analysis

Share Price


Exhibit 30

Source: Capital IQ, SSR Analysis

Sector Ratios

The rigid packaging companies are the leanest in the Paper & Packaging space. When you’re talking about mass production of billions of cans, there’s a high degree of automation and for the most part a 12 ounce can is a 12 ounce can so you are largely competing on the basis of cost; this is where scale and efficiency matter. BLL offers a modest dividend yield, CCK pays none despite solid cash flow and no immediate obligations coming due. While Crown’s debt ratios are above average and they have made two $1B+ acquisitions within the past year, by offering even a small yield they could attract a new pool of institutional investors who have BLL on their radar since they pay a dividend and ignore CCK since they do not. R&D expenditures for BLL and CCK are lower than some of their packaging peers, but not insignificant – these are mainly geared toward specialty packaging.

Exhibit 31

Source: Capital IQ, SSR Analysis

Exhibit 32

Source: Capital IQ, SSR Analysis

Exhibit 33

Source: Capital IQ, SSR Analysis

Exhibit 34

Source: Capital IQ, SSR Analysis

Exhibit 35

Source: Capital IQ, SSR Analysis

Exhibit 36

Source: Bloomberg

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