SEE - Sealed Air: No Air For Investors

Summary

• Sealed Air has steadily grown the business in recent years.
• Shares have been trading stagnant and leverage has come down a bit, so have expectations.
• Current multiples do start to look appealing, despite a profit warning for the remainder of the year.

Shares of Sealed Air ( SEE ) gathered some attention over the past week as they fell in response to a substantial deal and a softer outlook for the year. My last take on the business goes back to May 2019 when the company acquired APS, as I was not warming up to the shares at the time.

Some Background

The story of Sealed Air has been a bit problematic. In 2017, the company sold Diversey in a deal which yielded the business a mere $2.5 billion in after-tax proceeds. What was left was a $4.2 billion food care and product segment, with earnings power seen around $2.00-$2.50 per share, while some leverage was still apparent on the books.

Forwarding to May 2019, shares stood at $43 per share as the company had grown to nearly $5 billion in sales, and earnings were reported around $2.50 per share, all while leverage ratios still came in around 4 times. The company supported a $10.3 billion enterprise valuation at the time, equal to just over 2 times sales and around 11 times EBITDA.

With leverage being fairly high, the company acquired APS in a $510 million deal, a bolt-on deal being valued at 5% of Sealed Air's own valuation. With a slightly lower sales multiple, solid growth and long-term potential in e-commerce and fulfillment, the investment looked quite solid if you ask me.

As I deemed the performance of Sealed Air not being that impressive and shares were trading at a market multiple, while leverage was very high and organic growth was only at the pace of GDP at best, I was urging for caution.

Fast Forwarding

The irony is that since early 2019 and today, about three and a half years later, shares are still trading at $43. Shares fell a bit around the time of the pandemic, hit a high around $70 at the start of this year, and by now have fallen back quite a bit again.

After posing flattish sales in 2019, revenues rose 2% in the pandemic year 2020, with sales up to $4.9 billion. With the pandemic not allowing for the same amount of selling activities, the company saw a huge boom in earnings, up from $1.70 per share to $3.24 per share. Adjusted earnings came in at $3.19 per share, up 13% from the $2.82 per share number posted in 2019.

Net debt has come down to $3.2 billion amidst some deleveraging, encouraging as EBITDA rose to $1.05 billion, to thereby reduce leverage to 3 times. So with earnings power trending at $3 per share and net debt coming down, that fundamental performance supported shares.

Amidst inflationary trends building up through 2021, full year sales rose 13% to $5.5 billion as the company managed to maintain margins and earnings. GAAP earnings rose twelve cents to $3.36 per share, with adjusted earnings reported at $3.55 per share as net debt was stable at $3.15 billion. EBITDA rose further to $1.13 billion, resulting in a leverage ratio below 3 times. The company guided for 2022 sales between $5.8 and $6.0 billion, EBITDA around $1.22 billion and earnings at a midpoint of $4.05 per share.

After a solid first quarter, the company hiked the guidance in a minimal fashion, yet shares fell from $70 in March to $43 at the moment of writing, despite little news flow. A general pullback in valuation multiples on the back of higher interest rates, higher input costs, inflation and concerns about slower growth were arguably drivers behind the valuation multiple compression.

The Third Quarter

On the first day of November, Sealed Air announced its third quarter results as the accompanied cut in the guidance was a bit shocking. Full year sales are now seen at a midpoint of $5.70 billion, a quarter of a billion cut from the previous guidance. To put it into perspective, this indicates a roughly 10% cut in the sales guidance for the second half of the year.

This is surprising as inflationary pressures results in higher pricing, indicating worsening volume trends. This image is confirmed by the guidance with respect to profitability as the EBITDA guidance was largely maintained at $1.22 billion with earnings seen around $4.10 per share.

Net debt inched up to $3.4 billion, inching up a bit amidst some share buybacks as leverage ratios continue to come in below 3 times. With 147 million shares trading at $43, the enterprise valuation comes in at $9.7 billion. This makes that multiples have compressed a bit, now trading at 1.7 times sales, 8 times EBITDA and around 11 times earnings, as notably these valuations start to look compelling.

Alongside the release, Sealed Air announced a $1.15 billion deal to acquire Liquibox. The company operates bag-in-box operations used for beverages and other foods, a rapidly growing segment. With $362 million in sales, the deal comes at a price of 3.2 times sales, roughly double the valuation of Sealed Air here on this metric. Based on EBITDA, the multiple comes in at 13 times albeit that realization of $30 million in synergies has the potential to reduce the EBITDA multiple towards 10 times.

This deal will increase net debt to roughly $4.5 billion on a pro forma basis, yet EBITDA might increase to $1.3 billion, pushing up leverage ratios to 3.5 times, which seems manageable.

What Now?

Shares of Sealed Air have fallen from $48 to $43 on the back of the news events this week, with the company shedding three quarters of a billion in value. This is in response to the poor earnings report and the deal, as the impact of both news events cannot be disentangled here.

The reality is that the deal looks a bit expensive, but well from a strategic point of view, as the sales shortfall is noteworthy for the second half of the year. Weighing it all together, I believe that valuation is improving here, and while leverage will increase a bit with the latest deal, it still seems manageable. Changes in the business model are needed as the company is still heavily tied to the usage of plastics, not really in accordance with ESG, to put it mildly of course.

With shares flat over the past 3 years, I note that Sealed Air has managed to reduce the share count a bit, increased sales by about a billion, as earnings have moved up to the $4 per share mark. Furthermore, the company has been able to announce an interesting recent bolt-on deal, albeit at a heftier price tag.

All of this makes that appeal has greatly improved here, although the cut in the full year guidance shows that volumes have taken a beating in recent weeks and months. Nonetheless, overall valuations look a lot more enticing here, and while I am not overly impressed with the long-term performance, a steady positioning and solid valuation attracts my interest to start initiating around the $40 mark.

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