PKG - Packaging Corporation of America: Approaching The Bottom Time To Re-Enter

2023-06-30 07:19:16 ET

Summary

• Packaging Corporation of America has a higher ROCE versus its competitors and deserves a premium valuation.
• Despite lower volumes, the company expects to rebound in Q2 due to its vertical integration and the dissipation of client de-stocking activities.
• PKG's strong balance sheet provides financial flexibility for shareholder remuneration and opportunistic capital allocation. Our buy is then confirmed.

Following our recent initiation of coverage of Smurfit Kappa , today we are analyzing Packaging Corporation of America (PKG). Since our latest update, released in early February, the company stock price has declined by 9.52% and is back to an attractive entry point.

Why are we optimistic about PKG?

1. Given our sector expertise and previous analysis , PKG's Return on Capital Employed is the highest among its peers (Smurfit Kappa: 21.8% , WestRock: 6.87%, IP: 11.29%, and Mondi: 21.64%). The company's 2022 fiscal year ROCE reached 23.09%;
2. Related to point 1, the best profitability ratio at the EBITDA level supports this. Indeed, in 2022, the closest competitor was Smurfit Kappa, with an American EBITDA margin of 19% (Fig 1), while PKG delivered 22.23% results. Packaging Corporation of America's competitor advantages are due to the following :1) clients' proximity with local & regional client that represents 70% of the company's total sales; 2) this proximity also helps to minimize supply chain expenses and reduce logistic complexity, 3) centralized procurement, 4) industry-leading vertical integration, 5)self-sufficient in energy production, and 6) direct sales representatives.In addition, we should also report PKG's EBITDA margin track record (Fig 2);
3. Again, to support point 1, ROCE is calculated with the operating profit margin at the numerator. PKG was able to reduce its net debt, thus lowering its quarterly interest expenses. This was also recorded in Q1 2023. In numbers, the company paid interest expense of $15.4 million compared to last year's quarter of $19.8 million;
4. Looking at the cash flow evolution, the company can ensure a secure dividend per share while investing for growth. Despite a depressed volume, operating cash flow was sufficient to meet CAPEX requirements and dividend payments . In addition, PKG's balance sheet is solid, and there is cash ability to repurchase the company's shares opportunistically.

Fig 1

Fig 2

Changes in Estimates:

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