1. Is the company undervalued?
EV/EBIT: 13.52
Price/Sales: 1.76
Price/Book: 3.63
$PKG while unsexy is a quality business, which trades at a large discount to the market. Furthermore the company should benefit from secular growth in e-commerce for years to come. This coupled with a shareholder friendly management team, makes $PKG an interesting investment idea.
2. Can I easily explain what the company does?
Yes they manufacture packaging material and paper, chiefly corrugated and containerboard.
3. Does the cash flow statement line up with income statement?
Yes, cashflows have been higher than reported earnings:
Most of their cash went towards capital expenditures and dividends, which I’m perfectly fine with. It’s important to note however that $PKG is a fairly capital intensive business. For example, ~ 55% of operating income was used on capital expenditures and almost all of this went towards maintenance (not growth).
4. Is the Balance Sheet Healthy?
Total Debt: $3.42B
Total Cash: $1.79B
Current Ratio: 2.31
Packaging Corporation of America holds very little debt relative to their market cap and only paid ~$96M in interest payments last year. This is less than 10% of operating income, which gives $PKG and extremely strong balance sheet.
5. How profitable is the business?
Gross Margins: 22.92%
Operating Margins: 15.27%
Net Margins: 10.03%
ROIC: 12.57%
$PKG has some impressive profitability numbers for a company that more or less manufactures a commodity product. While gross margins are less than desirable, all other metrics are average to above average. Moreover $PKG has been fairly consistent in regards to profitability, with operating margins reaching no lower than 12.46% in the last decade.
6. What is the company’s growth potential?
6-yr Revenue CAGR: 2.17%
6-yr EBIT CAGR: 1.48%
6-yr FCF CAGR: 11.65%
$PKG had a large acquisition in 2013, which is why I chose to analyze growth from 2014-2020. With that said top and bottom line growth have been anemic. Additionally the free cash flow growth here is overstated. For instance, if you measure FCF from 2015-TTM, the number is actually negative.
Nonetheless $PKG should benefit from the growing adoption of e-commerce. We now live in an era where people can make a living selling candles out of their home. This should benefit $PKG and management just guided for a ~ 53% increase YOY in EPS for the upcoming quarter. In summation I don’t think it would be unreasonable to forecast 5% growth moving forward.
7. Is management rewarding shareholders?
Packaging Corporation of America currently offers a 2.97% dividend, but does not repurchase shares. Furthermore there’s no buyback plan in place and they haven’t repurchased shares since 2016.
I find this move bizarre as $PKG has historically traded in the 12-18 EV/EBIT range. After announcing earnings next quarter, the company should be trading around a 11X EV/EBIT multiple (assuming the share price is the same). IMO share buybacks would be a better deployment of capital and I’m curious to see if management changes their capital allocation decisions moving forward.
8. How does the company stack up against their peers?
Packaging Corporation of America’s biggest competitor is WestRock Company $WRK
$WRK Price/Sales: 1.68
EV/EBIT: 15
Operating Margin: 7.83%
$WRK is objectively more expensive and less profitable, although they’ve grown at a faster rate than $PKG. Furthermore both companies return roughly the same amount of capital back to shareholders. The tie breaker here is balance sheet health, as $WRK holds significantly more debt compared to $PKG. For these reasons I believe $PKG is the better risk adjusted bet.
9. What’s the counter argument?
The counter argument is that input costs will rise for $PKG and they won’t be able to pass along these costs to consumers. Additionally there’s limited acquisition opportunity, which will lead to slower growth.
At this point it’s impossible to claim that inflation is transitory and management has stated that higher operating and logistics costs are putting pressure on margins. The good news is that $PKG has been able to raise prices thus far. The company also preannounced price increases for the upcoming quarter, which is typically a good sign. With that said this can only go on for so long before customers find cheaper options.
Finally I’m sure there’s some truth in a dry acquisition market, but candidly I’m not interested in businesses that grow thru outside purchases. I believe $PKG should be able to grow organically, even if that growth is modest.
10. Is there something I think the market may be missing?
I don’t think the market is missing anything on $PKG per say. However I do think it’s an underfollowed and underappreciated name. The stock has only gone up ~61.5% in the past 5 years compared to 110% for the S&P, which has likely caused investors to lose interest. This is a sleepy name that could all of a sudden rip on unexpectedly good news.
Final Thoughts:
$PKG is an attractive idea given the low valuation, steady growth, and shareholder yield. Although it doesn’t smack me across the face as a no brainer. It’s likely the company outperforms over the next 3-5 years, but there’s no massive right tail outcome. Even forecasting out a bullish thesis of 5% growth, a 3% dividend, and multiple expansion to 15X, the company only has an expected return of ~18% over the next 3 years. Nevertheless it’s a stock worth tracking as, $PKG would be more interesting if the multiple compressed further or management implemented a share repurchase plan.
***Disclosure: I have no position in the security mentioned above, nor do I have any plans to purchase within the next 72 hours. This article is intended for educational purposes only and in no way should be interpreted as investment advice