It would stand to reason that a company's products that help extend the shelf life of food and/or offer improvements in customer experiences would do pretty well. And to a certain extent, that has been true for Bemis (NYSE:BMS). At a minimum, Bemis has been an excellent dividend stock. The question now, though, is whether investor expectations are running a little too high for a company whose competitive advantages don't really translate into clearly superior returns on capital or free cash flow (FCF).
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Even Staples Can Be Sluggish
The bulk of the business for Bemis is built around flexible packaging and, within that, the food and beverage industry. That puts the company in basically the same boat as Sealed Air (NYSE:SEE) and Sonoco (NYSE:SON), while differentiating it from others in flexible packaging like AptarGroup (NYSE:ATR) and MeadWestVaco (NYSE:MWV).
Supplying the food and beverage industry ostensibly sounds like a good thing - after all, those are stable businesses because people always have to eat and drink. The reality, as demonstrated over the last few years, is that this sector is more price elastic than commonly thought. In particular, customers have switched away from higher-priced goods to private label products that often uses less innovative or expensive packaging materials.
To that end, packaged food companies across the board have been reporting weak volume trends, and Bemis saw a 5% decline in volume year over year in the third quarter of this year (back in October).
SEE: Supply, Demand, And Elasticity
Will a Greater Focus on Profits Spur Better Returns?
While Bemis has a good record of innovative product development (including products like FreshCase films that extend the life and improve the appearance of wrapped fresh meat), that only goes so far in the industry. For starters, companies like Sealed Air are innovative too. What that means, then, is that sometimes innovation is only enough to stay in the race and there's a limit to the price leverage such innovations can produce, all of which has led to so-so operating margins.
Bemis has also been a pretty active acquirer, but that these deals haven't always been margin-accretive.
Now, the company and the industry on the whole, seems to be paying more attention to the "blocking and tackling" aspects of their businesses in the face of weaker volume and price trends. Bemis has trimmed back a bit on capex; has shuttered smaller, less efficient plants and has moved to cull underperforming products and customers. None of these moves are particularly sexy, but with 1% of FCF margin worth around $50 million in FCF (about 50 cents per share) in one year alone, it's well worth doing.
SEE: Which Is Better?: Dominance or Innovation?
Familiar Issues of Value and Growth
Within the flexible packaging sub-industry, Bemis has a relatively high exposure to North America and Latin America, but relatively low exposures to Europe and Asia. Over the long haul, given the growth in consumer purchasing power, Bemis probably needs to be more active in building up its emerging market business. On the industry side, building a bigger presence in healthcare would likely also be a good move, given the relatively lower cost sensitivity of the end users.
It's also worth asking if the company can, or will, jettison its pressure sensitive materials business. While the company has done a good job of boosting profitability and should be able to grow the graphics side in North America, it hasn't been a great business for the company.
The biggest issue of all, in my opinion, is the likely growth trajectory for the company and the market's expectations regarding that growth. There are multiple ways to approach concepts like "owner earnings" and "intrinsic value," but it looks to me as though the market presently expects Bemis to grow just as fast, if not faster, in the next decade as it has over the past - something that relatively few companies manage to do. Likewise, a FCF analysis would seem to suggest that investors expect some combination of revenue growth well in excess of the addressed markets and exceptional improvement in FCF conversion.
The Bottom Line
I won't underestimate the ability of Bemis to produce better margins, nor do I want to overlook a very strong history of dividend growth here. Conservative investors looking for reliable dividend-payers can certainly put Bemis on that list. That said, it's hard to arrive at a fair value number that suggests a lot of upside, and investors should be careful about overpaying for a company that likely cannot grow its way out of a too-demanding valuation.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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