With Ball Corp, Quality Doesn't Come Cheap

By Stephen D. Simpson, CFA | January 02, 2013 AAA

It's always a great thing to acquire the shares of a quality company at a discount to their long-term fair value. Unfortunately, those opportunities are not all that common; while it's my experience that there's always some quality companies trading below fair value, an investor may have a long wait when it comes to particular companies. To that end, while I believe Ball Corp (NYSE:BLL) is a fine company, and maybe the best in packaging, today's valuation doesn't look like any particular bargain.

Top Investment Trends For 2013: We go over a few investment trends for you to think about for 2013.

Hardly Kicking the Can
Ball Corp has built quite the franchise in metal packaging. The company has about a 40% share of the North American beverage can market and about one-third of the metal aerosol can market as well, counting both PepsiCo (NYSE:PEP) and Coca-Cola (NYSE:KO) as major customers. Moreover, the can/container markets are largely responsible oligopolies in North America and Europe - Crown Holdings (NYSE:CCK), Rexam (OTC:REXMY), and CCL Industries (TSE:C.CCL.B) generally don't look to compete on the basis of cutthroat pricing.

Metal containers aren't really a growth business in developed markets. Companies have looked to cut packaging and shipping costs by switching to plastic or other alternatives when possible, but there's only just so far this can go - I don't think we're going to see beer or soda sold in pouches anytime soon.

On the other hand, emerging markets are still meaningful growth opportunities. China and Brazil are huge beer markets, but penetration of cans is well below North American levels. Likewise, soda consumption is still below developed economy norms, and canned/packaged foods are becoming increasingly popular.

SEE: Beeronomics: Factors Affecting Your Pint

Adapting to the Realities of the Markets
One of the things I like about Ball is that management follows pretty rational strategies for its respective markets. The company lost a 2 billion-plus unit soft drink can contract earlier in 2012 and responded with capacity reductions in North America. A few years earlier, Ball saw limited prospects for its plastic packaging business to live up to its margin/return goals, so it sold those units.

At the same time, the company has been adding capacity in markets such as Brazil, China and Vietnam to keep up with the burgeoning demand in these regions. Ball is also selectively aggressive with acquisitions - looking to add capacity (and market share) in areas such as aerosol cans in Latin America and Asia.

Aerospace Still the Outlier
All of those positives aside, I still don't quite get Ball's ongoing interest in aerospace and defense. This business is about 9% of sales and is profitable (carrying roughly the same EBIT margin as the company as a whole), but it clearly doesn't have much in common with beer cans or hair spray cans. Ball's management has generally been good about building value for shareholders and returning capital to them, so I have to wonder whether its aerospace business wouldn't be worth more in the hands of a larger, committed player such as Boeing (NYSE:BA) or Lockheed (NYSE:LMT).

SEE: Evaluating A Company's Management

The Bottom Line
Analysts have long pitched Ball as a reliable performer in this industry, pointing to its generally stable customer relationships, its emerging market growth potential, and its solid record with margins and free cash flow (FCF). As a result, these shares don't often trade at substantial discounts to fair value, and today is no exception.

If Ball can grow its free cash flow at a rate of 4% for the foreseeable future, that suggests a fair value in the mid-$40 range. Even if the company can match its trailing 10-year free cash flow growth rate of about 6%, that still only points to a fair value around $50. Relative to a price of about $46 today, that's not enough undervaluation to be all that compelling, though the quality of this company is such that I'd be in no hurry to sell if I already owned shares.

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

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