The stock of Greif (NYSE:GEF), a company that makes industrial packaging products like drums (steel, fiber or plastic), rigid bulk containers and paper packaging, is one of those that is pretty frustrating to investors, as you have to be willing to buy (or sell) into considerable uncertainty. While 2013 looks like it will be a challenging year for industrial companies, investors are also likely to be on the lookout for signs of bottoming, and Greif could do well on that trade.
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A Challenging Business Gets Harder
It's not as though Greif is accustomed to operating in easy times. The business of making and selling steel drums doesn't necessarily lend itself to a sizable economic moat, and the company has always been vulnerable to end-user demand trends in industries like chemicals and cost pressures (the company buys over a million tons of steel every year). What's more, with refurbished/reconditioned drums getting more popular, Greif has had to adapt with the times and enter this business as well.
Even still, fiscal 2012 managed to be a little harder still. Volume was weak (or choppy, at best) for much of the year, and Greif had a relatively weak year from an earning perspective. The arrival of Hurricane Sandy certainly didn't help, as it knocked more than a few refineries and chemical plants offline for a short time. It also hasn't helped matters that the company's flexible packaging business (multiwall bags) continues to disappoint, despite fairly significant investments in the business.
But Is the Worst in Sight?
Roughly 40% of the company's business comes from Europe, so the health of the continent is clearly important to the company's fortunes. To that end, it's worth asking if the European industrial sector has made it past/through the worst of this downturn. Likewise, while growth in the United States seems to have clearly slowed in recent months, will 2013 simply mark a pause in the recovery?
I don't pretend to have a crystal ball when it comes to macroeconomic trends. That said, I do know that stocks like those of Greif tend to stabilize and start rebounding ahead of the actual printed improvements in GDP and industrial production. By the time it's obvious that Europe is back on its feet and the U.S. economy has resumed its growth, this stock will likely have had a run.
At the same time, Greif should get some tailwinds from its paper packaging business. While this is a relatively small business compared to the rigid and flexible packaging, increasing prices in the sector should be helpful as should a greater industry-wide focus on profitability. Packaging Corp (NYSE:PKG) and Rock-Tenn (NYSE:RKT) are more leveraged to that trend, but it should mitigate some of Greif's challenges in the rigid packaging business.
Weighing the Long-Term
I do have some long-term questions about Greif's business. On one hand, it's for me not to prefer a name like Sealed Air (NYSE:SEE) or Bemis (NYSE:BMS) where there has been a greater historical focus on innovation. In addition, Greif's history of free cash flow (FCF) production is both erratic and not all that impressive (average FCF margins are sub-4%).
On the other hand, it's not like Greif hasn't delivered good returns on capital at several points in its history, or shown respectable growth in owner earnings. What's more, the company has been very active in recent years with acquiring businesses and adding facilities, and I believe there should be meaningful margin leverage opportunities. Last and certainly not least, there's that leverage to an economic/industrial recovery to consider - just because Greif may not have the hallmarks of a long-term holding, that doesn't mean it can't be an effective holding over a shorter period.
The Bottom Line
Greif does not look especially compelling over the long-term from a FCF perspective. Although I think the company should be able to produce revenue growth in line with (or a bit ahead of) developed world GDP, I don't have huge confidence that the company will deliver significantly better FCF; I believe the company can, I'm just not confident it will.
By other valuation metrics, though, Greif looks a little more interesting. The company's EV/EBITDA ratio is not very high, and the implied growth in owner earnings is not unreasonable. So while I don't necessarily see so much value in Greif that I'd make a long-term commitment, holding Greif as a recovery idea is more compelling.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.