2024-01-10 10:30:00 ET
Summary
- O-I Glass' share price has been sliding due to reduced full-year guidance, but the company is on the verge of commissioning a new plant.
- Despite a weaker-than-expected third quarter, the investment thesis for O-I Glass remains intact, with adjusted earnings per share increasing compared to the previous year.
- The company's cash flow performance is a key factor in the investment thesis, and while the Q3 cash flow was somewhat disappointing, the 9M 2023 cash flow result was robust.
Introduction
I have been a fan of O-I Glass ( OI ) for several years now and I was surprised to see the company’s share price slide again since this summer. Sure, the company’s debt load and increasing interest rates on the financial markets aren’t a great mix, but the company is on the verge of generating a very robust amount of free cash flow as its first Magma plant will be commissioned later this year.
Meanwhile, the high capex required to complete the MAGMA plant is hiding the true underlying cash flow potential of the company.
Despite the subdued share price, O-I Glass may surprise you
While the company’s third quarter was definitely weaker than expected, the entire investment thesis remains intact. The company reported a total revenue of $1.74B which resulted in a gross profit of $364M. Unfortunately, some of the other operating expenses remained high and O-I Glass saw its pre-tax income drop to just $82M.
But as the image above shows, the ‘other income/expense’ had a major impact on the comparable basis of both quarters. Excluding this element, the Q3 2022 EBT would have been $144M while the Q3 2023 EBT would have jumped to $188M. This ‘other expense’ was mainly related to a $78M restructuring expense. Despite this, the company remained profitable as it reported a net income of $56M of which $51M was attributable to its own shareholder. This resulted in an EPS of $0.32. The adjusted earnings per share came in at $0.90 compared to $0.63 in the same quarter last year.
I generally don’t like ‘adjusted’ earnings as it feels like there’s always something that can be adjusted. Instead, I have built my investment thesis for O-I Glass around its cash flow performance. Let’s first have a look at the Q3 cash flow performance.
As you can see below, the company reported an operating cash flow of $339M after adding back the $78M in non-cash restructuring expenses. Investors are cautioned the $339M in operating cash flow also contains a $125M contribution from changes in the working capital position. This means the adjusted operating cash flow was $224M.
The Q3 cash flow statement above also shows the total capex was $197M, resulting in a free cash flow of $27M. Disappointing? Yes, somewhat. And even looking at the 9M 2023 cash flow result, there’s nothing to get really excited about.
The reported operating cash flow was $437M, which includes a $416M investment in the working capital position which means the adjusted operating cash flow was $853M. Plenty of cash to cover the $465M capex, resulting in a net free cash flow of approximately $390M.
This very robust 9M 2023 result was overshadowed by the company’s updated guidance reflecting a deteriorating expectation for Q4 . Initially, the company anticipated an adjusted EPS of $0.25-0.35 for the fourth quarter but it has now revised that result down to $0.03 per share, resulting in a full-year adjusted earnings result of $3 per share.
The fourth quarter is generally the company’s weakest quarter but that doesn’t mean I’m happy with the anticipation of what essentially is a ‘break-even’ situation in the fourth quarter.
That being said, I have always approached O-I Glass as a cash flow story, and that still is very much how I look at the story now. As you can see in the guidance above, O-I Glass still anticipates to generate $100-150M in free cash flow, but this includes the substantial investments in the Kentucky-based MAGMA plant which will be commissioned later this year.
Fortunately, the company also provides a free cash flow guidance excluding these growth investments. As you can see below, about $300M of the capex is classified as strategic/expansion. This means the underlying free cash flow result excluding these growth investments will be $400-450M.
Let’s now simply assume O-I Glass meets the lower end of this already reduced guidance. $400M in free cash flow divided over 155M shares outstanding results in a net free cash flow of close to $2.60 per share. Would you pay $15.5 for a stock that’s generating $2.60 in underlying free cash flow?
The quick answer would be ‘yes.’ My answer is ‘yes, if its capital allocation strategy makes sense.’ I get it. In 2023 (and 2024), the investment in the new Kentucky plant will require the vast majority of the incoming free cash flow, but once that plant has been commissioned, I would expect O-I Glass to spend hundreds of millions per year to reduce its net debt position. At the end of September, the company had a net debt level of close to $4B and although this already meets the company’s plan to reduce the debt ratio to less than 3 times EBITDA, I would like to see the company trying to reduce the debt ratio even further, perhaps towards 2.5 times EBITDA.
Even if O-I would not reduce its debt ratio, I don’t anticipate the company seeing a substantial increase in its interest expenses as its bonds on the secondary market are trading at or very close to par. But considering the average cost of debt exceeds 6%, reducing the net debt by $300M by the end of 2026 would result in a boost of about $0.10-0.12 to the free cash flow result on a per-share basis.
Investment thesis
I currently have a long position and I have started to write put options on O-I Glass again. Due to the recent volatility, the option premiums are pretty attractive and a put option with a strike price of $15 expiring in February can be sold for $0.60 while a P14 for May can be sold for $0.80.
At the current share price of $15.50, O-I Glass is trading at just 4.5 times the 2024 consensus EBITDA which is pretty attractive. Even if you’d apply a multiple of 5.5 times EBITDA, you are looking at a fair value in the mid-$20 range. I will continue to add to my position in O-I Glass, but I may also have a look at the company’s bonds as the 2027 bonds are trading with a yield to maturity of 6.6% while the 7-year bonds have a 7.3% yield to maturity which I think offers an attractive risk/reward ratio.
For further details see:
O-I Glass: A Cash Flow Monster In Disguise