It's hard to argue that Silgan (Nasdaq:SLGN) doesn't have a very attractive business with pretty significant barriers to entry. Silgan has a better than 50% share in North American can markets, and likewise substantial share in its closures business. What's more, other competitors like Ball (NYSE:BLL), Crown Holdings (NYSE:CCK) and Berry Plastics (NYSE:BERY) tend towards the rational when it comes to pricing. Couple that with a strong emphasis on returning capital to shareholders (with dividends and buybacks), and you have what looks like a strong company.
The question with Silgan, though, is the extent to which it can adapt with the times. As food producers have switched from glass to plastic, I expect the same to happen over time with metal. While Silgan can offset some of that with expansion into emerging markets, I have to ask whether the company also needs to grow beyond metal cans to maintain its long-term earnings power.
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Cash Flowing out in Multiple Directions
Silgan certainly doesn't seem afraid of debt. The company has not only committed to a $250 million modified Dutch auction in February, but also share buybacks. At the same time, the company spent just under $250 million to acquire Rexam's (OTC:REXMY) high-barrier plastic thermoformed food container business.
As of the last quarter, Silgan had about $1.6 billion in net debt outstanding. That's close to nine years' worth of free cash flow (FCF) using the average of the past four years, and it's also more than three times the trailing EBITDA for the firm.
On one hand, I'm not too worried. About 20% of the company's revenue goes to Nestle (OTC:NSRGY) and Campbell Soup (NYSE:CPB), with companies like Del Monte and Hormel (NYSE:HRL) also representing meaningful amounts of business. That business is not likely to go away anytime soon; even with some contracts coming up next year, Silgan rarely ever loses major customers.
On the other hand, that debt does chew into the fair value. I appreciate the fact that debt is almost always cheaper than equity, and I likewise appreciate the long-term potential from the Rexam deal. Nevertheless, it's still a lot of debt for a company with inconsistent FCF generation.
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Thinking About Long-Term Growth
Silgan has a pretty good history of building shareholder value over time, and the implied growth there doesn't seem unreasonable. That said, it's still worth thinking about the company's long-term growth outlook.
More than half of the company's business is in the food market, and that's not an especially high-growth opportunity. That suggests to me that the company needs to look to emerging markets and product expansion for growth.
The Rexam deal is a good example - although the company is paying a high multiple (more than nine times EBITDA), there's good growth potential in those microwavable plastic bowls and trays (like the Hormel Compleats packaging). As time goes on, I would think that a lot of food items currently sold in metal cans will migrate to plastic packages like pouches, and I think Silgan needs to grow its plastic packaging business to take advantage of it.
Right now, though, the company is putting a lot of emphasis on expanding into the Eastern European market for metal cans. It's a logical move given the available market share there represents the potential for Silgan to replicate its North American share overseas, but I still think that plastic/flexible packaging is going to be an increasingly important area.
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The Bottom Line
Valuation is tricky when it comes to Silgan, and it's not just because of the turbulence from Hurricane Sandy that led to a disappointing fourth quarter warning. Looking at the FCF picture, it's hard to see Silgan delivering revenue growth well ahead of GDP growth without further deals, so that suggests to me that the company has to deliver substantially better FCF margins - and I'm not sure that's a realistic goal.
FCF isn't the only way to value a company, though. Looking at the company's intrinsic value (or shareholder/owner earnings), it looks like the market is expecting growth on the order of 4%. That seems reasonable given that it's well below the growth of the last decade and not demanding relative to expectations for global GDP growth, the potential for margin improvement, and product/margin expansion. As a result, Silgan isn't the most obviously cheap stock today, but I can see where investors could see long-term potential here with a management that has built value over the last decade.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.