Monday, February 6, 2017

Graphic Packaging Holding Company Stock Analysis

5 steps
  1. Is it something I can identify and understand?
  2. Is the revenue/profit growing?
  3. Does it pay a dividend and is it covered?
  4. Is it trading at a discount to the market and why is it trading at a discount?
  5. What do analysts think of this stock?
  6. What are the potential risks?


Step 1: Is it something I can identify and understand?


What separates a pre-civil war fence nail vs a post-1850s nail? Part of my investing career have been an absolute failure because I had no idea what I was investing in or had all the facts before entering. As Peter Lynch famously said, “Never invest in any idea you can’t illustrate with a crayon.” GPK makes packaging for many multinational companies such as Kellogg’s (K), Coca Cola (KO), and Kraft-Heinz (KHC). Many companies cut cost by outsourcing the cardboard and aluminum containers to an outside company allowing them to focus more on internal organic growth. At some point in your life you probably have been in contact with a GPK product.






Step 2: Is the revenue/profit growing?


Some people want 20-30% revenue growth year over year. Some people want 1000%. I like sustainable growth. Is the revenue steady and can it at least grow a little bit every year? Can a company continue to grow year after year and not fall into the too big to grow issue? I call this the Apple (AAPL) conundrum. At some point a big company can’t continue growing 20% year over year like the old days. Growing $100 Million to $250 Million is a lot easier than growing $100 Billion to $250 Billion. I enjoy companies that grow sustainably and increase its dividends over time. In my experience these companies tend to fare better over time than the majority of the high risk/high reward stocks.




“2016” in my charts refers to the trailing 12 months. Meaning that the data is current as of today. It is subjected to change upon earnings release.  If 2016 is not included, the data was not available or impossible to calculate. GPK’s revenue and net income have been flat for four years, but let’s dig a little deeper and find out why. GPK revenue peaked in 2013 and only since 2016 started going back up. I reviewed past transcripts and determined a few things that caused the drop:
  1. GPK divested numerous lower margin factories and focused on its higher margin brands in 2013.
  2. In 2014, GPK made a bigger push into the European markets. At the same time GPK debt was huge and management was aggressively paying it off. More of the debt issue will be discussed below. Reviewing the past transcripts, it looks like GPK was leverage at 3x debt to asset ratio in 2014. By not fully investing the divested monies into new factories and acquisition, GPK revenue lagged for two years.
  3. In 2014-2015, weaknesses in the dry cereal and soda markets caused a slowdown in revenue. GPK is more of an industrial stock than a true defensive stock. It relies heavily on demand of other companies products.
  4. Although a small sample, it looks like from 2015-2016 management has straighten the revenue ship. Note that even though revenue dropped in 2015, GPK was able to increase its net income.
  5. Please also note the dip in operating margins in 2014, but the huge and sustaining jump in 2015 and 2016 ttm.




Earnings per share and free cash flow have been all over the place. We do see that since 2013 when management decided to take the company into an entirely different direction FCF has skyrocketed and EPS made a significant jump in 2015. Does that guarantee that 2016 FCF and EPS will continue to increase? No, but there is a high correlation between the increase in 2015 revenue, net income, operating margin, gross margins, eps, and FCF carrying into early 2016 ttm numbers.


Step 3: Does it pay a dividend and is it covered?


Everyone has a different ways of determining dividend coverage. I am more of a conservative investor and prefer dividends paid from free cash flow. Any company that pays dividend from money it doesn’t own is likely to go bankrupted. I am limiting my review to only 2015 and 2016 because these are the only two years that GPK paid dividends.


Year
2015
2016
Operating Cash Flow
589
633
Capital Expenditure
-244
-321
Free Cash Flow
345
312

So far in 2016 TTM, the capex has increased by ~$80 Million while the operating cash flow has increased by ~$40 Million. It is concerning that for every dollar spent on Capex $0.50 goes to operating cash flow. However, this is a complex business and I am in no position to question the management. I just wanted to point out this 2:1 ratio. The big question is are the dividends covered? Earlier in 2016, mangement increased the dividend by 50% from $0.05 to $.075.


Year
2015
2016
Free Cash Flow
345
312
Stock repurchase
-85
-157
Dividends paid
-49
-65
other financing act
-1
-6
Total
210
84


GPK’s dividend is fully covered by its free cash flow. In fact it is covered 4.8x if the 2016 stock buyback was cancelled. GPK nearly doubled their stock repurchase in 2016 and increased their dividend paid out by $16 Million. But the most important question is answered. GPK is paying its dividends from cash flow and not borrowing debt.


Step 4: Is it trading at a discount to the market and why is it trading at a discount?


As many on SA love to say, the market is never wrong! You are! The market is trading approximately around 26x P/E. GPK is trading at 16.68x P/E. So why is GPK cheaper than the market? To be honest I don’t really know. GPK is not being sued by the US government or in any legal battle. If I were to make two guess it would be:
  1. GPK is an outlier in the packaging industry,
  2. GPK downgraded its full year expectations, and
  3. GPK’s debt.


Regarding the first, GPK’s main competitors are Bemis (BMS) trading at 20.4x PE with a dividend yield of 2.33%, Silgan Holdings (SLGN) trading at 20.3x PE with a 1.3% dividend yield, Sunoco Products (SON) trading at 23.1x PE and a 2.74% yield, and Grief Inc (GEF) trading at 33x PE and a 3.26% yield.


Regarding the second, in its 3Q earnings, GPK expects a 1-3% EBITA growth vs the predicted 4-7% for the full year of 2016. GPK reported that in the third quarter, volumes increased by 2.5% driven by acquisitions, but decreased 1.4% in core volume. And the A.C. Nielsen reported that the food and consumer volume declined mid to single digits. GPK followed with this trend. However, increase in beverage volume remediated some of the declining food and consumer volume. Analysts expect a $0.15 eps and 19% decrease in revenue Y-o-Y. Meaning coming into the fourth quater, analysts aren’t expecting much out of GPK. In my opinion this could be the perfect time to strike. If GPK misses, it will get hit but not much because analysts weren’t expecting much. However, if it beats expectation watch GPK soar. Who knows what will happen. GPK is reporting on February 7, 2017.
The third is also a big problem. From a debt to equity ratio, GPK is near 3x leveraged, but digging deeper it looks like GPK have been aggressively lowering its debt.


Year
2011
2012
2013
2014
2015
2016
Debt Issued
92
2,667
2,154
2,208
903
1,467
Debt repayment
-339
-2,738
-2,234
-2,475
-979
-1,208
Total Debt
-247
-71
-80
-267
-76
259


Year
2011
2012
2013
2014
2015
Short Term Debt
-30
-80
-77
-31
-36
Long Term Debt
-2,336
-2,254
-2,176
-1,942
-1,839
Total Cash on Hand
272
52
52
82
55
Total Cash after Paying Short Term Debt
242
-28
-25
51
19


In 3Q, GPK paid down $22 Million net debt and decreased net leverage ratio to 2.89x from 2.93x. Global liquidity stands at $1.1 Billion. As a dividend investor I don’t like the high debt, but I do like management aggressiveness and commitment in paying off debt. I believe GPK is trading at a discount because of its lower expected guidance and higher debt ratio.


Step 5: What do analysts think of this stock?


  1. Thomson-Reuters rate GPK a Positive 9: Buy Rating.
    1. Low target: $14.50
    2. Mean target: $15.20
    3. High target: $16.10
  2. Yahoo Finance
    1. One year target: $15.22
  3. Simply Wall Street
    1. Future Cash Flow Value: 18.96
  4. The Street
    1. Quant Rating: B (Buy)


Average of the three analysts: $16.46
Kick out the outlier: $15.21


Step 6: What are the potential risks?


GPK relies exclusively on consumer demands. Not any consumer demand, but demand for their client’s products. As such, GPK relies on the consumers willing to buy Kellogg’s cereals, drink a coke, or use Kraft’s ketchup. Trying to predict what product will be en vogue next season is like calling market tops and bottoms. Next to impossible. GPK can only acquire diverse clients to offset this risk.


This is just my speculation, but another risk is possible regulations in the packing industry. California and many other states have banned the use of plastic bag and styrofoam takeout boxes because of their inability to decompose. I am not arguing if this is right or wrong, but there is always a possibility of stricter regulations on cardboard boxes, aluminum cans, and plastic bag/wrap.


Conclusion:


Although not perfect, GPK is currently trading at a discount to the market and analysts predictions. There is a huge negativity coming into the fourth quarter earnings. If it misses, GPK will see limited downside trading at such a discount as it is. If it beats or meets expectation, I can see a jump towards fair value range. In either case GPK has enough free cash flow to pay its dividends while paying off its debts. I am not arguing that you should invest in GPK. All investment should be done after careful scrutiny and investigation. I’m just asking for an open mind towards this little treasure.


So what are your opinions on GPK?

Disclaimer: I am not a financial adviser. these are just my opinions.

6 comments:

  1. What an excellent analysis of a quality stock here. I am interested in taking a look at this stock in the future if the right opportunity presents itself. Cheers

    ReplyDelete
  2. Great Analysis BDI. Very intrigued by this company. It wasn't on my radar before your post but I'm certainly going to add it to our watch list now. It appears that GPK has done a great job in the last few years with getting rid of their debt and now piling on cash. Not a long history (yet!), but this could be a future DGI stock, given their low payout ratio and cash flow.

    Thanks for sharing. BTW, hope you don't mind, I've added this to our Collection of Stock Analyses. ;)

    Regards, AFFJ

    ReplyDelete
    Replies
    1. no problem AFFJ, thanks for adding me to your list

      Delete
  3. Wow that is an amazing analysis. I haven't encountered the stock yet, but I start elimination all stocks above a 20 P/E so that's probably why.

    ReplyDelete
    Replies
    1. hey evan, it just broke 20x after they rally. still a great company. a bit of debt but it's working hard to lower it down. thanks for visiting

      Delete