2023-10-10 14:40:20 ET
Summary
- Sonoco's operations seem quite low-risk as the consumer packaging segment represents the majority of revenues and the company's earnings are historically stable.
- The company does have a high amount of debt, but the company's stable cash flows should be able to safely cover the debts.
- At the current price, Sonoco seems undervalued according to my DCF model estimate, constituting a buy-rating.
Sonoco Products Company ( SON ) produces packaging products for various industries. Considering the company’s modestly low risk profile and sound acquisitions, I believe the stock is priced quite low – as the company’s earnings should recover in the medium-term after a recent period of slower demand, I believe the stock is worthy of a buy-rating.
The Company & Stock
Sonoco produces and sells packaging in the consumer segment as well as industrial products along other, quite insignificant segments:
Sonoco's Offering (sonoco.com)
The consumer segment represented around 54% of Sonoco’s revenues in Q2, and the industrial segment represented 34%. I believe that the consumer segment is a more valuable one to have revenues in – consumer packaging seems to be largely very defensive in nature, as Q2 sales pertly represented; consumer packaging revolves largely around food products, which have constant demand.
Sonoco’s stock hasn’t had a very good return in the medium-term past – the stock price is around the same price as five years ago – investors’ only return in the period is Sonoco’s dividend yield, that currently stands at 3.83% with forward estimates.
Five-Year Stock Chart (Seeking Alpha)
I believe the stock could experience some multiple expansion, as will be explained in the valuation segment.
Financials
In the company’s long-term history, Sonoco has achieved some growth – Sonoco’s compounded annual growth from 2002 to 2022 stands at 5.1%:
Author's Calculation Using TIKR Data
The growth hasn’t been completely organic – Sonoco does seem to have quite frequent acquisitions . For example, in September, Sonoco acquired RTS Packaging for $330 million almost a year after the acquisition was originally announced. The company's cash flow statement also shows the frequency of the inorganic growth - Sonoco has cash acquisitions in every year from 2013 to 2022.
After a strong 2022, Sonoco’s revenues have decreased slightly in the first half of 2023 as a result of softer demand – in Q2, the consumer segment’s net sales decreased by 7% and industrial sales decreased by 20% as per the company’s Q2 presentation .
Sonoco has achieved a very stable EBIT margin in the company’s history – the margin has ranged from 7.6% to 10.9% with an average of 8.7% in the period from 2002 to 2022:
*Analysts' Consensus Excluding Extraordinary Items For 2021 (Author's Calculation Using TIKR Data)
The margin also seems to have grown in the years, as the slope is mostly positive – Sonoco has achieved some operating leverage from the inorganic growth that has resulted in synergies. The company is facing some small issues around its margin in 2023 due to softer demand, as in the first half of 2023 the company’s EBIT margin fell by 1.1 percentage points. The earnings are still on a very healthy level, as the trailing margin of 10.3% is above Sonoco’s long-term average.
Sonoco leverages debt well to its advantage – the company currently has around $3.1 billion of long-term debt, of which around $0.4 billion is in the current portion of the debt. Compared to Sonoco’s market capitalization of $5.2 billion, the debt balance seems very high. I believe that the amount of debt is still very safe for Sonoco and provides opportunistic financing for the company – Sonoco has demonstrated a very stable history in terms of earnings and cash flows, making the leveraged balance sheet safer.
Valuation
After 2021, Sonoco’s forward price-to-earnings ratio fell significantly into a figure that’s well below Sonoco’s long-term average – the current forward P/E of 10.3 is around 34% below the ten-year average of 15.7:
Although interest rates have seen a significant rise in the past years, I don’t believe the rise explains the seemingly higher required rate of return for the stock. To further analyse the valuation, I constructed a discounted cash flow model.
In the model, I estimate a revenue decrease of 5% for 2023, signifying a slightly better H2 after a H1 revenue decrease of 6.8%, in line with analysts' expectations. For 2024, I estimate a growth of 6% as the company’s demand should start to normalize after the communicated slow demand in 2023; the growth represents a jump back into a level that's only slightly above 2022. Although the timeline could vary with economic uncertainty, the recovery in demand should happen eventually.
After 2024, I estimate a growth of 4% for a couple of years, after which the growth slows down into 2% in steps. The estimated growth is below Sonoco’s long-term average of 5.1%, but as I don’t account for acquisitions in the DCF model, I believe my estimates are fair for Sonoco’s organic performance.
For Sonoco’s EBIT margin, I estimate the margin to scale slightly after a decrease of 0.8 percentage points in 2023 – the slow growth back into an EBIT margin of 10.9% is in my opinion reasonable as Sonoco’s demand normalizes and the company’s revenues increase – the margin leverage is mostly in line with Sonoco’s long-term history as represented in the financials segment. I estimate the company to have quite large capital expenditures and slight working capital increases in the future, contributing to the free cash flow conversion in the model.
The mentioned estimates along with a cost of capital of 7.53% craft the following DCF model with a fair value estimate of $72.01, around 34% above 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 Q2 Sonoco had around $34 million in interest expenses. With the company’s current amount of interest-bearing debt, Sonoco’s annualized interest rate comes up to 4.49%. The company leverages quite a high amount of debt, as the company’s cash flows are mostly very stable – I estimate a long-term debt-to-equity ratio of 30%.
For the risk-free rate on the cost of equity side, I use the United States’ 10-year bond yield of 4.78% . The equity risk premium of 5.91% is Professor Aswath Damodaran’s latest estimate made in July. The beta of 0.70 is taken from Yahoo Finance’s estimates . Finally, I add a small liquidity premium of 0.4%, crafting a cost of equity of 9.32% and a WACC of 7.53%, used in the DCF model.
Risks
As Sonoco's long-term growth includes a large number of acquisitions, the visibility into organic growth in the long-term is somewhat limited - if growth doesn't seem to recover back into positive levels without the help of acquisitions in the next few quarters, the DCF model's assumptions could be wrong in terms of growth and the buy thesis would be largely wrong.
Although I don't believe the debt is too significant of a risk for the company, it is important to note that Sonoco does have a large amount of debt. In a scenario where Sonoco's cash flows are impaired for a prolonged time, the debts could be detrimental.
Takeaway
At the current price, Sonoco is priced at a seemingly low forward P/E of 10.3 widely below the company’s long-term average. My DCF model also points the stock to be undervalued at the moment – I believe that the current price represents a buying opportunity. Sonoco is currently facing softer demand mostly in the industrial segment, but as the demand should recover back in the medium term, I don’t think the soft demand should be an issue for investors – I have a buy-rating for the stock.
For further details see:
Sonoco Seems Cheap Considering The Risk Level