Sonoco Products – Solid Performance (NYSE:SON)

In the final days of 2021, I concluded in this premium article that shares of Sonoco Products (NYSE:SON) looked quite attractively valued amidst new ambitions. The company has seen better operating performance at the time as it ended 2021 with a substantial acquisition, warranting an update that revealed that Sonoco looked quite attractive.

The Base Case

Sonoco posted 2020 results which were impacted by the pandemic in a relatively limited way. Full-year sales fell just over 2% to $5.2 billion as revenues have been stagnant for quite a few years at the time.

The business is essentially comprised of two large segments. The consumer packaging business is responsible for nearly half of sales at $2.4 billion. This is complemented by a $1.9 billion paper and industrial covered products business, complemented by a smaller display & packaging, and protective solutions segment.

Margins were a different story. Sonoco posted adjusted earnings of $3.41 per share in 2020, yet GAAP earnings only came in at $2.05 per share, with the discrepancy stemming from a range of adjustment items including amortization charges, restructuring charges and acquisition related costs. Fortunately, the company has been cleaning up the situation with regard to pension fund liabilities in quite a big way.

Net debt of $1.1 billion came in at 1.4 times leverage based on $782 million in adjusted EBITDA as the company guided for 2021 earnings to come in at around $3.50 per share, as actual results were largely in line with these expectations. The company outlined solid guidance for 2022, guiding for earnings of around $3.90 per share. With a $7.0 billion enterprise valuation (including $1.3 billion in net debt) by year-end 2021, the company announced a big deal towards the end of the year.

Sonoco reached a $1.35 billion deal to acquire Ball Metalpack, adding production of tinplate food, aerosol cans, closures and other items. With $850 million in sales and $111 million in EBITDA, multiples look reasonable, albeit that they marked a modest premium versus its own valuation.

Pro forma net debt would jump to $2.6 billion, and with pro forma EBITDA seen at $873 million, leverage ratios would jump to 3 times. While the deal looked a bit pricey, in terms of EBITDA multiples and leverage incurred, the company was essentially guiding for earnings of $4.00 per share in 2022, albeit traditionally some adjustments were made to these earnings.

With shares trading at a mere 14-15 times earnings, as leverage was high, adjustments to earnings on occasions show up, and long-term operating performance has been mixed, I still saw potential for a small re-rating at $57.

And Now?

Fast forwarding from the end of last year to today, we see shares trading flat at $57. Shares have mostly traded in a $50-$65 trading range and with this flattish result, shares have seen a big outperformance versus the wider market here. That comes as a surprise, as Sonoco is leveraged of course, certainly after last year’s acquisition.

A lot of news has happened since the end of 2021. For starters is that the deal for Ball Metalpack closed in January. In February, the company posted its 2021 results, a year in which revenues rose by just over 6% to $5.59 billion as adjusted earnings were posted at $3.55 per share, albeit GAAP losses were reported due to pension settlement charges.

The company introduced a $4.60-$4.80 per share earnings outlook for 2022 (after initially guiding for earnings at $3.90 per share late in 2021). Note that this guidance now specifically excludes amortization expenses. If this same accounting was applied to 2021 earnings, that number would come in at $3.93 per share. Net debt stood ticked up to $1.44 billion, a point of attention given the recently closed deal, which of course did not show up in the 2021 results yet.

The impact of inflation and the deal were seen in the first quarter results with revenues up 31% to $1.77 billion as adjusted earnings came in at $1.85 per share, and GAAP earnings showed up at $1.17 per share. Net debt jumped to $3.02 billion, a huge increase and higher than expected, albeit somewhat offset by better profitability as I see EBITDA trending close to a billion here.

Second quarter sales rose as much as 38% to $1.91 billion on the back of these developments (the deal and aggressive price hikes) on which adjusted earnings of $1.76 per share were reported, with GAAP earnings coming in at $1.33 per share. The peak of the profits was clearly seen as the company announced a $1.35-1.45 per share adjusted earnings guidance for the third quarter, with full-year earnings seen at a midpoint of $6.25 per share, suggesting that some further earnings declines are seen in the final quarter of the year.

This momentum clearly makes that valuations are coming down as a 14-15 times multiple by year-end 2021 has fallen to 10 times earnings, or just below. Some retained earnings helped net debt fall to $2.95 billion, and while EBITDA surpassed the billion mark based on the results in the first half of the year, some weakness is obviously seen in the second half of the year. If EBITDA is set to arrive at $1.15 billion this year, leverage ratios will have come down to 2.5 times, which is getting a bit more comfortable than a 3 times handle.

Strong recent quarters helped Sonoco announce an $88 million bolt-on deal to acquire Danish-based Skjern Paper in a deal set to add $50 million in sales, indicating that this is truly a bolt-on deal with revenues surpassing the $7 billion mark per annum here.

Concluding Remark

With Sonoco’s shares flat so far this year, this actually marks a 25% outperformance versus the wider markets. Clearly, Sonoco has seen a very strong first half of the year, but simultaneously it guides for softer performance in the second half of the year. Moreover, net debt is far higher than I anticipated, somewhat troubling in a rapidly rising interest rate environment.

Hence, I am happy with the outperformance, although I am happy to cut out a small part of my position in exchange for investments else, purely based on the relative performance. At the same time, I am keeping a small long position after the first half of 2022 certainly has not disappointed me.