AptarGroup: When A Great Business Doesn't Mean A Great Stock

By Stephen D. Simpson, CFA | October 10, 2012 AAA

I wish I could like AptarGroup's (NYSE:ATR) stock as much as I like the business. After all, there's something to be said for a company that has leveraged its expertise in valves, pumps and closures to become a leading player in products like fine-mist spray pumps, lotion pumps, nasal spray pumps and a variety of innovative food and beverage packages. Unfortunately, it looks like the Street is already well acquainted with the good points of this company, and the stock sports a fairly demanding valuation.

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Personal Care Taking a Powder
When companies such as Unilever (NYSE:UL) and Beiersdorf (OTC:BDRFF) need pumps for personal care products like Axe Body Spray or Nivea lotion, they look to AptarGroup. As a result, this company holds the first or second market share spot in product categories like fine-mist spray pumps and lotion pumps. Although there is competition from a host of private companies and some public companies like MeadWestvaco (NYSE:MWV), product design is important, and consumer companies have to carefully balance the merits of saving a few pennies per unit with alienating customers through inferior products.

These aren't great times for AptarGroup's home and beauty business. More than half of its business comes from Europe, and tougher conditions there and in the United States have led to lower consumer spending (and to consumers trading down in the market for cheaper goods). From 3% core growth in the first quarter, performance slid to basically flat results in the second quarter and it would seem optimistic to hope for a major rebound this year.

Pharmaceuticals are the Crown Jewels
While various pharmaceutical products (especially nasal spray pumps and metered-dose inhalers) comprise about one-quarter of the company's sales, they make up more than half of the company's profits. AptarGroup has extensive IP in this business, as well as clean-room facilities in several countries. Drug companies are loathe to change product packaging for approved prescription drugs (as it can create complications with the FDA), and many generic and OTC manufacturers work with AptarGroup once the prescription drugs go off patent.

While MeadWestvaco and West Pharmaceutical Services (NYSE:WST) offer some competition, this is a large addressable market. Perhaps one of the biggest questions for management is whether they want to broaden their offerings - going beyond pumps and inhalers and perhaps into some of the injector pen products sold by companies like Becton Dickinson (NYSE:BDX).

As has been the case in the personal care business, sales growth has been petering out this year. Worse yet, acquisitions and new plant openings have been leading to some margin compression - while the adjusted segment operating margin of over 27% in the second quarter is still quite good, count on investors to watch this number carefully over the next couple of quarters.

SEE: Things You Didn't Know You Could Copyright

Food And Beverages still a Growth Opportunity
Although food and beverage companies don't generally sport the same margins as drug or personal care companies, there's still a strong market opportunity for innovative packaging products in the food and beverage market. AptarGroup has, for example, designed a new ketchup squeeze bottle for Heinz (NYSE:HNZ), a custom closure for PepsiCo's (NYSE:PEP) Tropicana and the packaging for Kraft's (Nasdaq:KRFT) MiO drink mix. While Bemis (NYSE:BMS) and Sealed Air (NYSE:SEE) are significant competitors in many food categories, there are relatively few others that address as many markets as AptarGroup (particularly in those segments with higher barriers).

SEE: Groceries You're Wasting Your Money On

Can The Company Do Better?
AptarGroup has a pretty solid record of generating mid-single digit organic revenue growth and sharing its success with shareholders through dividends and buybacks. Moreover, the balance sheet is in relatively solid shape.

Unfortunately, some of the company's financials are less impressive. The company is certainly targeting growth opportunities in emerging markets, but more than 80% of the company's business is currently in the mature European and North American markets. Worse still, the company's free cash flow conversion has been sub-standard for most of the past decade due in large part to higher capex and working capital needs.

SEE: Free Cash Flow: Free, But Not Always Easy

The Bottom Line
Better free cash flow conversion would indeed be good news for shareholders, and it should be possible as the company starts leveraging past investments. That said, analysts and investors have already baked in quite a bit of future improvement.

If AptaGroup can deliver 8% free cash flow growth over the next decade, the stock is pretty significantly overvalued today and even a low-teens growth estimate doesn't produce a compelling fair value. Consequently, while I believe AptarGroup will continue to enjoy an economic moat and post solid results, I worry that expectations are already ahead of the stock. This would be a good name to consider on a pullback, but the valuation simply seems too rich today.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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