MYE - Greif: Still Worth Considering Even After Shares Took A Hit

2023-12-18 09:43:29 ET

Summary

• Greif, a packaging company, has seen a decline in share price and weak financial performance, with revenue dropping 17.8% in 2023.
• Despite the worsening conditions, shares still appear attractively priced and a soft 'buy' rating is still appropriate.
• This is due, in part, to the fact that Greif continues to make investments in growth initiatives, including recent acquisitions, indicating long-term potential for the company.

One of the dangers of value investing is that, sometimes, the market isn't entirely wrong. Sometimes, it's entirely right. And other times, it is correct in assessing the direction that a stock should take but wrong about the magnitude of the pain or upside. As an example, let's look at a packaging company called Greif, Inc. ( GEF ). Back in July, I wrote an article wherein I rated the company a 'buy'. In that article, I acknowledged that financial performance was deteriorating. But even with that deterioration, I felt as though additional upside was warranted. This was based on how cheap shares were, both on an absolute basis and relative to similar firms.

Since the publication of that article, shares have seen a downside of 8% while the S&P 500 is up 5.2%. This comes on the back of continued weakness on both the top and bottom lines. And to make matters worse, management has even provided some rather painful profitability guidance for 2024. The good news is that while the market was correct to predict additional pain, thereby driving down the share price, absent a worsening of the fundamental condition that exceeds what management is forecasting, shares still look attractively priced. Naturally, developments have caused me to become a bit more cautious regarding the company. But with how much upside exists on the table, I would argue that a soft 'buy' rating is still appropriate right now.

The pain is worsening

Back when I last wrote about Greif, we only had data covering the first two quarters of the 2023 fiscal year. Today, we now have data covering the rest of that year. And what a year it was. During 2023 , revenue came in at $5.22 billion. That represents a drop of 17.8% compared to the $6.35 billion generated in 2022. The biggest downside for the company during this time came from its Global Industrial Packaging segment. Revenue plummeted 18.9%. 2.2% of this decline was driven by foreign currency fluctuations. Even though the company decreased prices and saw a change in product mix that negatively impacted revenue to the tune of 6.6%, that did not stop volume from plummeting by 10.1%. The Paper Packaging & Services segment, meanwhile, reported a 14.9% decline in revenue. 9.9% of this drop was driven by lower selling prices and a change in product mix. And even in spite of that, volume hit revenue to the tune of 5%.

On the bottom line, Greif experienced some weakness as well. Lower prices and volume declines had an understandably negative impact on profitability. Net income managed to fall from $376.7 million to $359.2 million. In addition to suffering from a drop in sales, the company also saw a decrease in its gross profit margin from 20.2% to just shy of 22%. This is common when you see volume declines and lower pricing on goods, especially with an asset-intensive industry. There were multiple other contributors, some of which helped the business and others of which hurt the business. As an example, interest expense jumped from $61.2 million in 2022 to $96.3 million this year because of higher interest rates. However, the company benefited this year from a $62.6 million swing in the sale of business assets.

From a cash flow perspective, Greif didn't have the worst time, but it didn't have the best. Operating cash flow ticked down modestly from $657.5 million to $649.5 million. But if we adjust for changes in working capital, we get a drop from $743 million to $591.2 million. Meanwhile, EBITDA for the company managed to drop from $917.5 million to $818.8 million.

In the near term, the picture for the company is likely to continue worsening. I say this because management acknowledged the deterioration in the space. They even said that because of this, they are guiding toward the low end of guidance for 2024. That would imply EBITDA for the year of $585 million. Operating cash flow should be around $600 million, while my own estimate for net profits should be roughly $256.6 million.

Using these figures, I was able to value the company as shown in the chart above. As you can see, the stock is more expensive on a forward basis using two of the three metrics that I looked at. In the table below, meanwhile, I compared the company to five similar firms. On a price-to-earnings basis, only one of the five companies was cheaper than Greif. One of the five was cheaper than it and another was tied with it when it came to the price to operating cash flow approach. And finally, when it comes to the EV-to-EBITDA approach, three of the five companies ended up being cheaper.

It is entirely possible that weakness in this space will continue for the next several quarters. However, it would be a mistake to think that management is only focused on the short term. The fact of the matter is that the company continues to make significant investments in various initiatives. From 2022 through 2023, management allocated $1.9 billion on things like capital expenditures, mergers and acquisitions, debt reduction, share buybacks, and dividends. About 40% of this was allocated toward growth initiatives. And most of that, about $550 million, was used on acquisitions.

The latest acquisition announced by the company was made public near the end of October of this year. That purchase of I PACKCHEM, a producer of premium HDPE and PET-based blow-molded jerrycans, Bottles, and other packaging items that operate 13 manufacturing facilities across eight countries. 60% of its sales are to the agricultural market, while another 28% involves specialty chemicals. According to management, the company ended up paying $538 million for this particular purchase. If we exclude potential synergies of $7 million per annum, the deal should bring in around $57 million worth of EBITDA each year. Another purchase was of Reliance Products. But management has not mentioned what the financial terms of that deal were. The only thing they did say was that it was done at a multiple of 6.75 on an EV to EBITDA basis. Moving forward, investors can expect further growth in this space. Management said as much, and they mentioned that the total market opportunity is about $3.1 billion, with growth somewhere around the low-single digit rate each year.

Takeaway

As things stand, I can understand why investors would be cautious. In particular, the thought that EBITDA might be only $585 million in 2024 when it did come in at $818.8 million in 2023, can be striking. That represents a meaningful weakening of conditions. Having said that, even with this weakness, shares of the company look cheap, both on an absolute basis and relative to similar firms. Add on top of this the current initiatives that the company is employing in order to grow even more, and I would argue that this is still a decent long-term play.

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