PKG - Packaging Corporation Of America: Unwrapping The Potential Through A Conservative Approach

Summary

• This article provides a comprehensive analysis of the past and projected performance of Packaging Corporation of America using a conservative industry and valuation approach.
• The article identifies PKG's strengths in its strong market position, operational efficiency, and focus on sustainable practices, while also highlighting potential risks and challenges.
• The article ultimately concludes that PKG presents a potentially attractive investment opportunity, with a projected IRR of 14% per annum, given its reasonable valuation and expected growth trajectory.

Intro & latest:

Packaging Corporation of America ( PKG ) recently held its Q4 2022 earnings call , where it reported impressive results. The company's net sales were $2.3 billion, up 10% from the same period last year, and its net income was $226 million, up 39% from last year. According to Mark Kowlzan, PCA's Chairman and CEO, the company benefited from increased demand for corrugated packaging, as well as higher prices for containerboard and corrugated products.

Kowlzan noted that "the demand for corrugated packaging remains strong across nearly all end-use markets," including e-commerce, food and beverage, and consumer goods. The company also experienced "significant cost inflation" related to energy, freight, and labor, but was able to offset these costs with higher pricing.

During the earnings call, PKG’s executives also discussed the company's capital allocation priorities, which include investing in maintenance and growth projects, returning cash to shareholders through dividends and share repurchases, and pursuing potential acquisitions.

Overall, PKG’s Q4 2022 results demonstrate the company's ability to generate strong revenue and earnings growth despite facing inflationary pressures. As Kowlzan stated, "We are optimistic about the opportunities ahead of us and believe we are well positioned to continue delivering value to our shareholders."

Investment Thesis:

The article analyzes Packaging Corporation of America's financial data over the past 10 years to determine if the company demonstrates growth, reasonable debt ratios, and a justifiable valuation. The analysis projects cash flow and earnings until 2033 and establishes a share price for that year using realistic multipliers.

PKG has demonstrated impressive growth (Chart below: Growth Metrics) over the past decade, with EBITDA, free cash flow, and cash flow from operations growing consistently. Despite investing heavily in acquisitions and capex, PKG has reduced its share count by 7%. However, free cash flow has lagged behind other growth metrics.

PKG's long-term debt liabilities have remained constant at $2.5 billion over the past decade, but this has effectively reduced the net debt-to-EBITDA ratio due to the company's $700 million cash on hand. The company's use of debt appears responsible, and the current levels would allow for taking on additional debt if necessary.

PKG's 10-year average EV/EBITDA is 8.7 (chart below: EV/EBITDA), while the 2022 ratio has compressed to 7.5. Overall, the article suggests that PKG demonstrates strong growth potential, reasonable debt ratios, and a justifiable valuation, making it a potentially promising investment opportunity.

Potential Return:

Looking at growth, we conservatively estimate a growth rate of 5% for EBITDA over the next decade, which is half the growth rate we saw in the past 10 years. While this growth rate may seem lower, it provides a decent margin of safety compared to the current situation. To estimate the potential return, we will use the EBITDA 2033 figure and the historic EV/EBITDA multiple of 8.7 to determine the enterprise value. By subtracting debt and adding cash, we can establish a rational market capitalization for 2033. Based on these inputs, we estimate that PKG's share price in 2033 should be $301.

By purchasing PKG at the current price of $134, a rational investor could expect a profit of $167 per share over the next 10 years, based on the estimated share price in 2033. In addition to the potential share price appreciation, shareholders are entitled to the free cash flow the company is producing. PKG's 2022 free cash flow per share is $4.9, and we conservatively estimate a 5% cash flow from operation growth rate for the next decade (again, half of the historic for the purpose of the margin of safety). The company has spent about 60% of its operating cash flows from acquisitions and capex over the history. We will continue projecting the figures with rate ratio. By utilizing these inputs, the company should be in a position to produce $10.6 of free cash flow per share in 2033, for a total of $93 of free cash flow to the benefit of the shareholders.

To summarize, an investor could potentially buy PKG at $134, sell at $301 in 2033, and collect $93 in free cash flow in total over the years, directly or indirectly, resulting in an IRR of 14% per annum. A $100 investment could potentially turn into $370 in 10 years. Overall, PKG appears to be a solid investment opportunity for those looking for reasonable growth, manageable debt ratios, and reasonable valuation.

Risks:

When considering investments, it is important to evaluate the potential risks and challenges that could impact the performance of the investment. For Packaging Corporation of America, there are several key risks and challenges to consider. Firstly, the industry is highly competitive, with numerous companies vying for market share. This can impact the pricing power of PKG, which could in turn affect its margins and profitability. Secondly, PKG is highly dependent on the price and availability of key raw materials such as paper and pulp, which are subject to market fluctuations and supply chain disruptions. This could impact PKG's cost structure and ultimately its financial performance. Thirdly, changes in regulations and environmental policies could also pose a risk to PKG's operations, as the company's business model is highly dependent on the use of natural resources. Finally, has been spending a significant amount of their cash flow from operations on capex and acquisitions to foster growth.

Conclusions:

Overall, our analysis of Packaging Corporation of America suggests a promising investment opportunity. Despite some risks and challenges, such as macroeconomic uncertainty and potential supply chain disruptions, PKG's strong financial performance and conservative valuation approach make it an attractive option for investors looking for stable returns. PKG has been spending a significant portion of its cash flow from operations on capex and acquisitions to foster growth, which positions the company well for future profitability. Additionally, our conservative valuation approach and growth projections suggest that investors who buy at the current price of $134 could potentially sell at $301 in 2033, collect $93 in free cash flow each year, and achieve an IRR of 14% per annum. Overall, we believe that PKG represents a compelling investment opportunity in the packaging industry.

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