2023-04-11 09:35:00 ET
Summary
- Ball is a leader in the aluminum beverage can industry.
- The company has invested billions in capacity expansion in the past few years.
- While the additional capacity was absorbed slower than I had anticipated, Ball should turn a corner in 2023.
- Expect a 10% EBITDA increase, and as the capex level will decrease, the cash flow statement should look much better as well.
Introduction
Ball ( BALL ) is one of the largest producers of aluminum beverage cans in the world. The company was trading with an "ESG premium" for several years but its valuation has now come down and Ball is now trading at more reasonable levels. The past few years Ball has been investing billions of dollars in expanding the production capacity, and as the capex will start to decrease from this year on, the reported free cash flow will increase.
The 2022 results were okay, but not more than that
The net income per share always has been relatively low for Ball, mainly because the company should be looked at from a free cash flow perspective as the sustaining free cash flow is traditionally substantially higher than the reported net income. Building a new plant requires a substantial initial capex, but while the depreciation of a new plant weighs on the income statement, the sustaining capex is pretty low.
But first things first, let’s have a look at the income statement as the net income of Ball will be used as a starting point for the cash flow statement.
In 2022, Ball reported a total revenue of just over $15.3B which is an increase of more than 10% compared to the revenue in 2021, mainly thanks to a price increase of the cans it produces.
Despite the higher revenue, the EBIT decreased due to the higher COGS. The $1.21B in EBIT was obviously still sufficient to cover the increased interest expenses and the bottom line shows a net income of $732M EUR of which $719M was attributable to the shareholders of Ball. This resulted in an EPS of $2.27 based on the average share count of 316.4M shares that were outstanding during the financial year. The net share count as of the end of last year was slightly lower and this would have boosted the earnings to approximately $2.30.
As mentioned before, Ball needs to be looked at from a free cash flow perspective. The reported operating cash flow in FY 2022 was $301M but this includes a very substantial investment in the working capital position of $905M. These are just normal elements in the course of doing business: As the revenue increases, it’s pretty normal to also see an increase in the total amount of receivables and inventory. This means the underlying operating cash flow was just over $1.2B.
Investors should be aware this includes $248M in "other" net cash outflows mainly related to restructuring expenses. These should be non-recurring in nature (and 2022 was a particularly big year as Ball also had to deal with its Russian division).
The total capex was $1.65B. That’s high and it indeed clearly exceeded the incoming operating cash flow and Ball was free cash flow negative. This did not cause any liquidity issues as Ball received in excess of $750M related to the sale of assets (including the sale of the Russian division, among others).
The capex will gradually decrease, and the reported free cash flow will increase
It's important to understand that a very large portion of the total reported capex was growth capex and that should be seen as a capital allocation rather than a stay-in-business capex. The sustaining capex is actually substantially lower than the depreciation expenses because, as mentioned, once a plant has been built, the depreciation expenses outweigh the ongoing capex requirements to keep the plant up and running.
In a previous article, I estimated the average sustaining capex to be around $75-80M per quarter . Let’s round this up to $400M per year. And perhaps even to $450M per year to account for inflation.
This means the underlying free cash flow using the $1.2B in adjusted operating cash flow would be around $750M or just under $2.50 per share.
While that still doesn’t make Ball exceptionally attractive at the current share price, keep in mind Ball (and all other beverage can producers) only expect to be fully able to pass through price increases to their customers in 2023. Additionally, some of the expansion projects will also start to contribute to the EBITDA and operating cash flow.
Looking at the average analyst estimates, the consensus calls for a $200M EBITDA increase in 2023 followed by an additional $150M increase in 2024 which means the EBITDA should jump from $1.96B to $2.3B. That’s $340M In additional EBITDA which should result in an additional net income and after-tax operating cash flow of approximately $250M which will boost the operating cash flow to $1.45B by the end of 2024.
Let’s round that down to $1.4B and assume a $475M sustaining capex (the sustaining capex will increase as the new plants will also start to require some sustaining capex to keep things running smoothly), the underlying free cash flow result will be roughly $925M or $3/share.
This will not immediately be visible in the income statement, but 2022 was the last year of very high capex investments. As mentioned on the FY 2022 conference call , the total capex will drop towards the approximate depreciation expenses from 2024 on (which will still include some expansion capex although that will obviously be a much lower amount than in 2022).
2023 CapEx will be in the range of $1.2 billion, driven by cash outflows related to prior year's projects. We will generate free cash flow in the range of $750 million in 2023 and initially focused on deleveraging.
[… ]
we've spent the capital we need to grow into over the next two to three years. We could most likely spend at D&A levels in 2024 and 2025. If we have a reason to invest, it will be with a strategic customer, one or two. So, I think you'll start to see a much more disciplined level loaded capital approach relative to D&A spend moving forward.
Investment thesis
While that still does not make Ball extremely cheap (the stock is also trading at an EV/EBITDA of 10 based on the 2025 expectations versus about 7-8 for its closest peers), keep in mind I have used pretty conservative parameters. The consensus estimates for 2025 are calling for a $2.5B EBITDA which should result in a $1.5B operating cash flow. Even if the reported capex comes in at about $600M, that’s still $900M in reported free cash flow and likely closer to or slightly exceeding $1B in sustaining free cash flow. I was clearly too early when I picked up Ball in 2022 I still like the outlook and prospects for the beverage can industry as a whole.
While I have been disappointed with the performance of the beverage can industry as a whole (as the demand for the cans in 2022 decreased faster than I had anticipated and it will take more time before the commissioned capacity expansion will be absorbed), I remain bullish on all three companies in the oligopoly. I have a long position in Ardagh Metal Packaging ( AMBP ) and have written put options on Ball and Crown Holdings ( CCK ) and as some of those options are currently in the money, I will likely have a long position in the common shares before the end of this year.
For further details see:
Ball: 2023 Will Be A Transition Year Before The Free Cash Flow Ramps Up