MeadWestvaco's Sum Of The Parts Doesn't Seem To Add Up To Value

By Stephen D. Simpson, CFA | January 03, 2013 AAA

MeadWestvaco (NYSE:MWV) has always been a little more willing than average to realign its business towards better long-term returns for shareholders. To that end, the company has been willing to divest/sell businesses (including its consumer and office products business (which merged with ACCO Brands (NYSE:ACCO)) while acquiring packaging and chemicals businesses in faster-growing areas like Brazil and India. That said, while MeadWestvaco does indeed look like a well-run packaging and specialty chemicals company, it's difficult to generate a cash flow scenario that suggests these shares are dramatically undervalued.

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A Solid Mix of Defense and Lower-Risk Growth
MeadWestvaco doesn't do anything particularly exciting, but value and GARP investors know that's no barrier to long-term value creation. MeadWestvaco is built around a large consumer packaging business, a specialty chemicals business, emerging market assets and a sizable land bank.

The company's packaging business is split between food, beverage and tobacco cartons/containers and a home/health/beauty business built around cartons and dispensing systems. In the case of the former, the company is basically a duopolist with Graphic Packaging (NYSE:GPK) coated bleached kraft (CUK) and boasts major clients like Coca-Cola (NYSE:KO) and Anheuser-Busch InBev (NYSE:BUD). The company, in the case of the latter, MeadWestvaco competes with other companies like International Paper (NYSE:IP) in cartonboard packaging, but also companies like Aptar (NYSE:ATR) and Rexam (OTC:REXMY) in pumps, sprays and other dispensing systems.

MeadWestvaco's specialty chemicals business is also quite notable - particularly as it has been an outsized profit generator in recent quarters. This business produces specialized carbon products for markets like automobiles, asphalt and energy, and one of the major products is fuel vapor emission canisters for vehicles. While the business is somewhat comparable to the Norit business acquired by Cabot (NYSE:CBT), they generally focus on different end markets.

SEE: Innovative Packaging That Packed A Punch

Emerging Markets Are a Key Focus
MeadWestvaco seems to appreciate that a lot of its future growth is tied to better penetration of faster-growing emerging markets (where, in some cases, packaged food is still a growth market). About 30% of the company's sales come from emerging markets, and the "Industrial" segment contains assets like the company's Brazilian packaging operations. MeadWestvaco has also invested in packaging capacity in India and has acquired Latin American chemical operations.

Is More Restructuring on the Way?
Investors seem to take it for granted that MeadWestvaco is going to eventually sell or spin off its specialty chemical business. Likewise, most valuation analyses of the company include the assumption that most of its 800,000-plus acres of forestland will go on the block eventually. While these transactions may (or may not) happen, there are other events going on at MeadWestvaco that are just as significant.

The company has made pretty substantial capex investments over the past couple of years, and I believe 2013 will be a year in which the company starts seeing better profit leverage from those investments. Likewise, I believe the company has underappreciated opportunities to grow its dispensing systems business and expand its carton business into new product categories. Then there is the emerging market angle - there would still seem to be ample opportunity to grow its operations in Latin America, South Asia and other regions like China and Africa.

SEE: Emerging Market With Best Potential

However, the valuation doesn't really work for investors. Even if the company finds ongoing success in emerging markets and specialty chemicals, it is difficult to see the long-term revenue growth rate exceeding 5% (on a compound annual basis). Likewise, even if MeadWestvaco becomes an industry standpoint in terms of profitability, I don't see the company pushing its free cash flow into the double-digits.

Even including $1 billion in value for the company's land bank doesn't really push the shares into value territory. While a base case scenario of mid-single digit revenue growth and high single digit free cash flow margins suggests a fair value in the $20s, it takes a revenue growth rate of at least 6% and a double-digit free cash flow margin just to get to today's price. Consequently, while I think MeadWestvaco will continue to be a very well-run company, it looks like the Street already expects a very high level of performance.

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

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