BLL & CCK – It’s the Geography, Stupid

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SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

Graham Copley / Nick Lipinski

203.901.1629/203.883.1927

gcopley@/nlipinski@ssrllc.com

January 20th, 2015

BLL & CCK – It’s the Geography, Stupid

  • The current multiple divergence between Ball and Crown does not seem to be supported by fundamentals. Compared to BLL, CCK has a better return on capital profile, far superior growth prospects, identical margins, a higher return on assets, and has been the beneficiary of rising estimates while BLL’s have been flat – yet BLL’s forward multiples are considerably higher than CCK’s – Exhibit 1.
  • One of the themes we saw in our group’s annual performance results was a relatively strong US versus a relatively weaker world BLL and CCK are pricing in the expectation that this dynamic will remain in place in 2015. BLL derives 60% of its sales in the US while 74% of CCK’s revenues come from abroad (including a European exposure of about 40%).
  • If you believe this is the year Europe finally picks up (seemingly a minority view today) and that low oil prices will help revitalize weakening global economies, CCK is significantly more levered and could quickly close the gap with BLL. In the case that the US remains the port in the storm, BLL could continue to see valuation support and CCK could continue to lag.
  • Relative PE and EV/forward EBITDA multiples for each stock are elevated versus historical norms (again, BLL more so than CCK) and both screen expensive on our return on capital driven models. BLL’s valuation appears fairly in line with earnings; CCK still has some room for valuation to catch up to its above trend earnings.
  • The multiple divergence between the two stocks is at an extreme not seen in a decade – historically they move very closely together and in the past, equalization has tended to occur very rapidly.
  • BLL would need to trade down to at least $50 a share to bring its multiples to a more normalized level (current price is ~$65) – this is also the price that normalizes valuation on our model. Crown would need to see a move to the $57 area (current price is ~$46) to bring valuation in line with earnings.
  • We note that Crown is likely also discounting some acquisition skepticism, having made two $1 billion acquisitions in the past 18 months. On the surface, both are positive moves – Mivisa is a European food can manufacturer with outsized margins relative to the industry, and EMPAQUE shifts Crown’s N. American beverage can mix (primarily soft drinks) more toward the better insulated beer segment and provides growth opportunities in still-developing Mexico.

Exhibit 1

Source: Capital IQ, SSR Analysis

Overview

Our initial research on this subject was aimed at justifying what appeared to be an extended multiple for BLL – the company is not markedly different than it has been in the past, return on capital has not improved and in fact has declined, revenues are flat out to 2016, estimates are unchanged, the yield is unsubstantial (0.8%), and the esoteric Aerospace segment has few if any internal synergies, the lowest margin in the portfolio, and is heavily tied to federal funding.

The inevitable comparisons to key competitor CCK saw the fundamentals slanting in Crown’s favor, but a multiple divergence in BLL’s favor. The simplest explanation for this seeming anomaly lies in the respective geographic exposures – Crown derives nearly three fourths of its sales internationally, while BLL is 60% domestically exposed. We
recently noted
in our monthly review that the broader Industrial & Material sectors’ 2014 performance results reflected relative strength in the US and relative weakness abroad – valuations for Ball and Crown are similarly reflecting this dynamic, and the expectation that it will continue into 2015.

Multiples for the stocks have moved steadily higher since the GFC but BLL pulled away over 2014 while CCK lagged. The recent sharp decline in Crown’s multiple came after the company warned of operational disruptions (related to political instability) in its Middle East businesses (about 8% of sales). This drew into sharp focus the difference in geographical exposures for the companies. In the longer term CCK will benefit from the continued development of global economies but for the time being investors are preferring the relative safety of the US, even as can volume growth remains sluggish at best. We note that historically the multiples tend to converge (Exhibit 2) and the current level of divergence has not been seen in a decade. If 2015 is the year Europe breaks out of its post-crisis malaise and revitalizes global economies in the process, CCK is meaningfully more levered and the gap could close quickly. If the status quo prevails, BLL could continue to see support while CCK lags.

Exhibit 2

Source: Capital IQ, SSR Analysis

Return on Capital

Return on capital employed for the can-makers reached a short term peak in early 2010. CCK peaked a few months after BLL and showed a less severe decline. ROC equalized in mid-2013, but the gap has since opened up again in Crown’s favor as Ball has lagged and remains below its 2010 high. The lows Crown experienced in the early 2000s were the combined result of an asbestos litigation, asset write downs, and certain tax charges. Excluding this period the companies track fairly closely, but because of this period of depressed returns CCK has a lower trend line which is causing the stock to look slightly more expensive than BLL on our framework – Exhibits 4 and 5. Note however that BLL has not been this expensive since the late 1980s.

Exhibit 3

Source: Capital IQ, SSR Analysis

Exhibit 4

Source: Capital IQ, SSR Analysis

Exhibit 5

Source: Capital IQ, SSR Analysis

Skepticism

Our skepticism work shows BLL’s valuation and returns are fairly well equated (the skepticism index value is close to 0). CCK looks more interesting here, and appears to have valuation upside to earnings – note the SI is at a level that has historically been the ceiling, and the R2 (measuring
the extent to which valuation is explained by return on capital
) is significantly higher than BLL’s. The SI shows us that investors believe that BLL can meet estimates but that CCK will not.

Exhibit 6

Source: Capital IQ, SSR Analysis

Exhibit 7

Source: Capital IQ, SSR Analysis

Growth Prospects & Estimates

Consensus estimates show BLL’s revenues are flat out to 2016. Cost actions will provide growth on the bottom line but the company trails competitor Crown considerably on this metric as well – Exhibit 8. These growth estimates are indicative of Crown’s emerging markets focus, an area where Ball is less exposed. Crown has been investing heavily in Southeast Asia; the Middle East and Africa remain growth markets despite the political distruptions of 2014; and the company controls its full stake in the Brazilian market (unlike Ball which has exposure to Brazil through a 50-50 JV). Ball does compete in China (22% market share to Crown’s 16%) but outside of a small equity JV in Vietnam and a plan to invest $40 million in a can plant in Myanmar, operations are limited to the developed markets of Europe and the United States.

Exhibit 8

Source: Capital IQ, SSR Analysis

The increase in Ball’s multiple over the past year has almost entirely been a function of investors paying more for the same stream of cash flows – EBITDA estimates are little changed in either direction for both 2015 and 2016. For comparison, CCK’s estimates are more than 12% higher than they were at the beginning of 2014 – Exhibit 9.

Exhibit 9

Source: Capital IQ, SSR Analysis

Portfolio Composition

Much is being made of the extruded aluminum opportunity (aerosol cans), a market that Ball entered in 2010 with the acquisition of Neuman Aluminum, and expanded into in 2011 and 2012 with purchases of European and Mexican firms. In total these acquisitions cost less than $500 million, and while these markets are, as the company delicately states in their 10-k, “growing faster than other parts of our business,” the addressable market reflects the dollar size of the acquisitions – Exhibit 10. Note that the beverage can market figure does not include non-Brazil South America, Russia, Australia, Japan, India, or Southeast Asia. Any growth in extruded aluminum is clearly not enough to move the needle, as revenues are flat out to 2016 as shown in Exhibit 8.

Exhibit 10

Source: Company Presentations, SSR Analysis

Beverage Can Market includes: China, Brazil, North America, and Europe ex. Russia

The divestment of Plastic Packaging is the only other notable portfolio shift at BLL in the past several years. This is a segment that accounted for 8.5% of net sales in its last year with the company and was not a catalyst for the enhanced multiple – the unit was sold off in mid-2010 and the multiple expansion only really took off over the past 18 months.

Aerospace – “A Good Business, Trust Us”

The poorly understood Aerospace segment has constituted a stable 10% of BLL sales over the past decade. Ball’s global presence and metal related know how make the company a consistent recipient of government contracts, but projects that seek to, for instance, develop a more environmentally friendly space fuel for satellites indicate few synergies with the low-cost, high overhead can production that is BLL’s core competency. Moreover, many of these government contracts are with the Department of Defense, and thus classified, making any insight into this business a near impossibility. This is kind of a case of: “this is a good business – trust us,” but the margin profile here shows Aerospace has been BLL’s lowest returning segment since 2009.

Exhibit 11

Source: Capital IQ, SSR Analysis

Crown has seen more noticeable changes, particularly over the past year and half during which the company has made two $1B acquisitions. The Mivisa transaction bolsters Crown’s European food can business – the acquired company has outsized margins compared to the industry and will largely be left intact. The more recent EMPAQUE acquisition positions Crown well in Mexico, where the middle class continues to expand. EMPAQUE is the former packaging unit for Heineken’s North American operations – this will shift Crown’s mix more towards beer and away from the relatively weaker carbonated soft drink segment that constitutes the bulk of its North American can sales.

Exhibit 12

Source: Capital IQ, SSR Analysis

Margins Equalized

More on the margin front: BLL does deserve some credit for the recent margin improvement. This improvement however has merely closed the gap versus CCK that had persisted since 2007, and consensus is not forecasting any major divergences over the next two years – Exhibit 13.

Exhibit 13

Source: Capital IQ, SSR Analysis

Optimism

Ball has historically been a very consistent self-estimator (2013 was the first year since the GFC that earnings came in below the January 1st estimate) with a better history of positive revisions than CCK. On a quarterly basis, however, while the annual results correctly predict a higher average earnings surprise for BLL, there has been considerably greater volatility associated with this result – Exhibit 13. This counters the “paying for stability” argument – further on that point, Ball’s dividend yield (0.8%) is preferable to Crown’s non-existent one, but we imagine our Consumer colleague Rob Campagnino could suggest a number of higher paying alternatives with similarly stable cash flows.

Exhibit 14


Source: Capital IQ, SSR Analysis

Exhibit 15

Source: Capital IQ, SSR Analysis

Exhibit 16

Source: Capital IQ, SSR Analysis

Currency

The strengthening dollar will be a headwind for both companies, but historically there is not much of a correlation between stock price and the $/euro exchange rate – the scatterplots below are monthly since 2012. Both BLL and CCK have a greater percentage of foreign assets than percentage of foreign sales, so translation risk seems like a bigger issue. For BLL the US accounts for 60% of sales but only 40% of assets. For CCK, the US accounts for 26% of sales but only 15% of assets.

Exhibit 17

Source: Capital IQ, SSR Analysis

Exhibit 18

Source: Capital IQ, SSR Analysis

Exhibit 19

Source: Capital IQ, SSR Analysis

Exhibit 20

Source: Capital IQ, SSR Analysis

©2015, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

 

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