2023-08-20 05:16:47 ET
Summary
- Ball Corporation sold its aerospace unit in a $5.6 billion deal, streamlining operations and reducing leverage.
- The divestment will cut net debt in half and improve leverage ratios, as the near-term impact on earnings is limited but potentially accretive.
- The investment case relies on the core business showing some improvements, after a tough operating environment, which is a big if.
Ball ( BALL ) is a major player in the production of aluminum cans, as the business hit the newswires last week after it sold its aerospace unit. The divestment is a noteworthy deal, set to streamline the aluminum can player's operations and reduce leverage.
While these objections are achieved with the transaction, it is a significant tax leakage and few earnings triggers which prevent me from getting upbeat here, despite a lagging share price, as I look for more pro forma clues before potentially reconsidering my neutral stance.
The Business
Ball is a major and diversified player for aluminum cans, counting major household consumer packing names as its clients, including the likes of Coca-Cola, AB Inbev, Campbell's, Heineken, L'Oréal and many others, while it served names like NASA and Boeing in the now divested aerospace segment.
The extent of the operations is very large as cans are gaining market share from other packaging forms, including glass of course. While cans dominate the market for energy drinks, there are still huge gains to be made in beer categories (certainly in some countries) and even more for regular sparkling drinks, which are often consumed out of plastic bottles.
The increased focus on ESG and recycling benefit aluminum cans as well. This comes as aluminum melts at lower rates than other materials (making it less energy intensive) with the compaction rate looking relatively favorable, materials being equally recyclable and no further separation needed. Following big investments made in the business, the company has grown the business to increase its production capacity.
For the calendar year 2022, the company grew full year sales by just over 10% to $15.35 billion, although that an inflationary environment made that operating earnings fell by 6% to $1.21 billion. Amidst higher interest expenses and a higher tax rate, net earnings were down 18% to $732 million.
Despite a modest pullback in the share count, earnings per share fell by forty cents to $2.25 per share. Adjusted for some items, notably amortization charges, earnings came in at $2.78 per share, down substantially from a $3.49 earnings per share number in 2021. The pullback in earnings came on the back of inflation, higher energy costs and the Russian divestment.
Net debt was reported at $8.4 billion at the end of 2022 which made that leverage was elevated at 4.3 times based on an EBITDA number just shy of $2 billion. Moreover, cash flow conversion was not very good, as full year capital spending of $1.7 billion surpassed depreciation charges by a billion, and that has been the case for two years in a row now. The 316 million shares outstanding at the time were valued at $55, thereby valuing equity of the business at $17.4 billion, and the entire enterprise at $25.8 billion.
Of interest, given the recent transaction, is that the aerospace segment generated $2.0 billion in sales in 2022, being responsible for 13% of total sales. Operating earnings of $170 million translated into high single digit margins, in line with the entire business.
2023 started a bit rougher on the back of the divestment and deflationary pressures, with first quarter adjusted earnings reported down 8 cents to $0.69 per share. With leverage being high, the cost of debt was increasing rapidly as the company priced a billion in notes in May with a 6% coupon rate.
Early in August, Ball posted second quarter sales which fell 14% to $3.57 billion as operating profits were reported at $321 million, and net earnings of $173 million working down to a GAAP earnings number of $0.55 per share. Adjusted earnings of $0.61 per share were down twenty-one cents on the year before.
Net debt actually ticked up to $8.8 billion amidst continued net capital investments and lower earnings power. Trailing comparable EBITDA fell to $1.91 billion, pushing up leverage ratios towards 4.6 times.
A Decisive Deal
In mid-August, Ball announced that it has reached a deal with BAE Systems in which it will sell its aerospace business in a $5.6 billion deal. With a roughly $2 billion revenue number reported by the unit, the company fetched a 2.8 times gross sales multiple.
Valued at a near 20 times trailing EBITDA multiple, Ball will see roughly $285 million in EBITDA being divested, although that the company can likely use the cash proceeds to avoid a similar number in terms of interest expenses. After tax proceeds are seen around $4.5 billion, which makes that net debt will be cut in half to $4.3 billion. Given that debt recently was issued with a 6% coupon, some $270 million in interest could be forfeited, which makes that the deal could even become accretive to earnings per share here.
Ball generated $1.9 billion in trailing EBITDA, and with the deal set to create pro forma EBITDA of around $1.6 billion, leverage ratios will fall overnight to 2.7 times, alleviating most of these concerns. With the net cash proceeds likely resulting in interest expenses being offset with the EBITDA being divested, leverage is addressed while the impact on earnings is likely very limited. Note that the company does not intent to deleverage as much, with $2 billion earmarked for share buybacks.
And Now?
With the company seeing another tough operational year, with adjusted earnings likely seen around $2.50 per share, before and after the aerospace deal, it is hard to become hugely upbeat. While leverage is addressed in a meaningful way, the earnings power remains an issue here.
Investors reacted positively to the deal, with shares gaining a dollar or two, adding over $600 million to the market value of the firm, although those gains were given back in the trading action which followed.
With shares trading around 20-22 times adjusted earnings and leverage being addressed, it is hard to get too upbeat, but we have to account for the factor that profits and margins have fallen quite a bit in the recent inflationary period, with operating margins down a few points here. This reveals potential as well, if the company can return to historical margins.
On the other hand, the company has seen a big retreat in the share price, with a $90 stock in 2020, 2021 and the first half of 2022, having come down 40% to $55 at the moment of writing. While the valuation was too high at the time, and appeal appears to be improving, the reality is that there are few triggers.
While leverage has been addressed, I fail to see an immediate earnings impetus here, amidst a high current earnings multiple and poor cash flow conversion due to continued investments into the business. Given these trends, I am pleased with the divestments, but I am waiting to see the impact of the dealmaking and streamlining of the business to re-consider my neural position over time.
For further details see:
Ball Corporation: A Look Post The Aerospace Divestment