2023-10-23 19:08:46 ET
Summary
- O-I Glass, a glass bottle producer, has performed poorly in the past two decades with no real growth despite acquisitions.
- The company has achieved a higher margin in H1 of 2023 as a result of higher pricing and cost efficiencies.
- I still worry about the margin's sustainability as well as the very low growth prospects.
- At the current price, O-I Glass is mostly priced to be a value trap. My DCF model estimates the stock to be roughly fairly valued, constituting a hold rating.
O-I Glass ( OI ) produces glass bottles. The stock has performed very poorly in the past ten years as acquisitions haven’t helped the company in achieving any growth in real terms. The company’s margins are improving in the current year as the company aims for cost efficiencies and a better pricing, but the efforts could prove themselves as flimsy as sales volumes have gone down. The stock seems to be priced for the weak financials at a forward P/E of 5.6, though – I have a hold-rating for the stock.
The Company & Stock
Founded in 1903 in Ohio, O-I Glass produces glass packaging for alcohol producers. The company mainly produces glass bottles meant for beer and wine products.
The stock hasn’t been a fantastic long-term investment – O-I Glass’s stock has halved in price over the past ten years, while only paying $0.25 per share in dividends, signifying a total yield of less than a percent with the late 2013 stock price. Moreover, the company doesn’t currently pay any dividends, although the company is considering a dividend.
Ten-Year Stock Chart (Seeking Alpha)
Financials
O-I Glass’ revenue hasn’t been very good. The company has achieved a compounded annual growth rate of 2.0% from 2002 to 2022:
Author's Calculation Using TIKR Data
At face value, the growth seems okay as it is mostly in line with inflation. What makes the growth bad is the fact that the performance is a result of multiple acquisitions. For example, in 2015 the company had a cash acquisition worth $2.4 billion, being worth around the same as O-I Glass’ current market capitalization. Other acquisitions have been smaller in size, but still contributed well into O-I Glass’ performance.
The revenue performance isn’t the only worrying financial metric for O-I Glass’ investors. The company’s EBIT margin has historically been on a slight decline in the long term. The company’s average EBIT margin from 2002 to 2022 is 11.5%, with the 2022 margin being 9.1% .
Author's Calculation Using TIKR Data
The company has achieved a better level in 2023 so far, as the current trailing margin stands at 11.7%. O-I Glass’ management attributes the strong margin into a favorable pricing in the period in the company’s Q2 earnings call . In the same call, the management mentions that volumes are down by 9% in Q2; although some of the lower volume could be attributed to a softer demand, it seems possible that the higher pricing has caused O-I Glass’ clients to refrain from purchasing in the period. O-I Glass does have margin expansion as a clear objective in the company’s strategy – part of the increased EBIT could very well be sustainable.
Margin Initiatives (O-I Glass Q2 Earnings Presentation)
O-I Glass has a large amount of debt, at least when compared to the company’s market capitalization. The company’s balance sheet reveals around $4.7 billion of long-term debt, of which $81 million is in the current portion. Compared to O-I Glass’ current market capitalization of $2.4 billion, the amount seems very excessive. The company needs to rely on stable cash flows from operations to be able to finance the debts as further equity financing to pay off debt would dilute investors’ shares massively. Compared to the company’s current levels of operating income, the debt doesn’t seem too unreasonable yet though – with trailing figures, around 32% of operating income has gone into interest expenses.
Upcoming Q3 Results
O-I Glass is reporting its Q3 results on the 1st of November in the post-market. Analysts currently expect revenues of $1.76 billion, representing a growth of 4.0% year-over-year. I believe that the estimate seems reasonable, as in Q2 the company's revenues grew by 6.3% - the estimated figure is roughly in line with recent performance, although does price in a slightly weaker quarter in terms of growth.
For O-I Glass' EPS, analysts are expecting a normalized figure of $0.70. The estimate approximates O-I Glass' margins to scale slightly, as in Q3 of 2022 the company had an EPS of $0.63 - revenues are expected to grow by 4% and the EPS by around 11%. In Q2, the EPS grew by 21% year-over-year as O-I Glass' margin performance has been good - the estimated earnings could be met with a slight positive surprise.
Valuation
O-I Glass seems very cheap on a price-to-earnings basis. The company’s current forward P/E stands at 5.6, below the company’s already low ten-year average of 7.8:
The P/E ratio doesn’t tell the entire story alone. O-I Glass has had a weak long-term history in terms of growth and margin development. The company is also currently investing heavily, resulting in weakened cash flows. On top, O-I Glass’ extraordinarily large amount of long-term debt poses a risk for shareholders. To further analyse the valuation, I constructed a discounted cash flow model in my usual manner.
In the model, I estimate a growth of 5% in 2023, signifying a slightly worse H2 as in H1 revenues grew by 7.3%. After 2023, I estimate a growth of 4% in 2024 as the currently softer demand could start to subside. The better amount of growth is in my opinion not probable to be maintained, though. For the period from 2025 to 2027, I estimate O-I Glass’ revenues to grow by 2%. After 2027, I estimate the growth to slow down further into a pace of 1.5%, meaning very slight decreases in volume if inflation continues at a long-term average pace.
For the EBIT margin, I estimate a figure of 12.0% for 2023 as the company’s pricing improves the margin. After the year, I estimate costs to catch up and pricing to come slightly down to keep up volumes – I estimate the margin to come down by one percentage point. Further, I estimate an EBIT margin decrease of half a percentage point in 2025 into a figure of 10.5% that is sustained into perpetuity. The mentioned estimates along with a cost of capital of 9.48% craft the following DCF model with a fair value estimate of $13.57, around 11% below the current price:
DCF Model (Author's Calculation)
The used weighed average cost of capital is derived from a capital asset pricing model:
CAPM (Author's Calculation)
In the first half of 2023, O-I Glass had $149 million in interest expenses. With the company’s total amount of interest-bearing debt, the company’s interest rate comes up to an annualized figure of 6.13%. O-I Glass holds a significant amount of debt on its balance sheet and has done so for a long period of time. I believe that the strategy will continue, as I estimate a long-term debt-to-equity ratio of 45%. The company does plan to deleverage the balance sheet slightly, but still to keep a high amount of debt as a form of financing.
For the risk-free rate on the cost of equity side, I use the United States’ 10-year bond yield of 4.91% . The equity risk premium of 5.91% is Professor Aswath Damodaran’s estimate made in July for the US. Yahoo Finance estimates O-I Glass’ beta at a figure of 1.38 . I believe that the company’s operations are very defensive in their nature, but as O-I Glass has a very high amount of debt, shareholders are highly leveraged in the operations. Finally, I add a small liquidity premium of 0.4% into the cost of equity, crafting the figure at 13.47% and the WACC at 9.48%.
Takeaway
Although the low P/E ratio seems like a good opportunity to buy the stock, I believe that O-I Glass’ investors should be cautious about the stock. The company has had a mostly bad financial history, and the company actively leverages a very high amount of debt. O-I Glass does have initiatives that aim to guide the company towards growth and margin expansion, but I believe the attempts shouldn’t be taken at face value; a long-term financial history speaks more in my opinion. The current stock price seems to agree with my thesis as the stock seems roughly fairly valued with my DCF model – for the time being, I have a hold-rating.
For further details see:
O-I Glass Could Be A Value Trap