Berry Global ($BERY) — Initiation (5/26/20)

Price: $41 Market Cap: $5.5bn Valuation: 6.8x P/FCF Category: CORE

This won’t be a lengthy post as I feel the investment is fairly simple…

Berry Global (BERY) is a manufacturing business making plastics, packaging, lids, containers, bottles, wipes, diapers, liners, etc.

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Berry does business with some heavy hitter customers:

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Quick Backstory

Berry Plastics (as it was once known) was private equity owned from 2006-2012 and came public via IPO in 2012 at $16 per share. They paid down some debt, levered up to make acquisitions, repaid some debt, and have once again levered up to make acquisitions (where we are today). Consider it a debt-fueled roll-up.

The company operates similar to a private equity firm executing a levered roll-up with debt levels consistently in the 4-5x+ EBITDA range — much higher than the ~3x or so that most businesses are comfortable with — the main reason shares are cheap today and have been cheap in the past…

On the flip side, this business consistently generates a ton of cash, and that cash flow has grown nearly every year…

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RPC Acquisition

In July 2019, Berry acquired European packaging business RPC for $6bn at ~8.5x EBITDA. They guided to $150m in cost synergies as part of the acquisition — roughly 3% of RPC revenue. Historically, Berry touts their ability to realize cost synergies at 5% of acquired sales in the 45 acquisitions completed meaning there could be some upside to the deal synergies.

RPC adds a pretty significant International element to the combined business:

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COVID-19 Impact

Things were going fairly well for Berry prior to coronavirus and based on comments from the latest earnings call, they appear to be well positioned for the current state of the world…

Outlook

While certain markets have been impacted by COVID-19 and related restrictions, we are fortunate to have such a diversified portfolio with strong, stable end markets. Our guidance has assumed COVID-19 related restrictions, such as shelter-in-place orders, continue for the remainder of our fiscal year. We believe approximately 65 percent of our portfolio is advantaged to neutral with about 35 percent disadvantaged related to COVID-19. We expect the coronavirus to negatively impact our volumes with a low-single digit decline, but believe that we will still generate growth in EBITDA for the back half of our fiscal year driven by cost synergies and improved cost productivity. The net negative impact we are anticipating related to COVID-19 on volumes and earnings are transitory. As the restrictions are lifted, we anticipate all our segments will return to positive organic growth, as demonstrated in the most recent fiscal quarter from the pre-COVID-19 volumes and earnings levels.

We are pleased to report that we expect our fiscal year 2020 free cash flow will be in excess of $800 million, which includes at least $1.4 billion of cash flow from operations partially offset by capital expenditures of $600 million. Cash taxes are expected to be $150 million, and cash interest costs are projected at $430 million assuming interest rates at the end of the March quarter. Additionally, we expect working capital, restructuring and other costs to be $50 million.

Cash Sources & Uses

Here are the past 8.5 years worth of cash flow statements for Berry — a thing of beauty:

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There are 133m shares outstanding for a $5.5bn market cap at a $41 stock price. Net debt is ~$10bn as of 2Q20 (3/31/20 in this case as Berry has a Sep 30 yearend). A $15.5bn enterprise value and $2bn in EBITDA = 7.75x EV/EBITDA. And if free cash flow is $800m / $6 per share in 2020 as predicted that would = 6.8x FCF multiple.

Some other notes from the cash flow statement:

  • You can see from the cumulative cash uses that Berry has dedicated nearly all of their efforts on M&A with almost $10bn spent from 2012-2019…
  • A negligible amount has gone toward share repurchases thought shares outstanding have increased from 112m in 2012 to 133m in 1Q20 — about 2% annual growth in share count
  • No dividends

So what does Berry plan to do from here?

The number one priority after the RPC acquisition is paying down debt… In the past, management has targeted 4x leverage as their goal but recent investor slidedecks have shown 3x as the target — this would be a change of pace for Berry toward a much less levered balance sheet…

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They’ve also highlighted $900m or $6.75 per share as a “normalized” free cash flow figure and the leverage goal being achieved within 2-ish years following the RPC deal…

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What’s the upside?

Berry could be a phenomenal long-term investment, particularly if they commit to a more “public market friendly” leverage goal (closer to 3x debt/EBITDA).

Can this business trade at 10x FCF = $60-70 per share? Definitely…

10x FCF = 5.7x operating cash flow… a multiple that Berry has traded at numerous times in the past with an average historical P/CFO multiple of 6.3x — typically after they digest a deal and get debt back in order…

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….When Berry acquired Avintiv in October 2015 it was a $31 stock and 2 years later traded at $55+ after “digesting” the $2.5bn acquisition.

With a fairly resilient business model and steady cash generation, Berry could offer 15-20% annualized returns over the next few years as they chip away at their debt.