Pactiv: Bumps in the Road Remain

Pactiv (PTV) makes disposable packaging products for consumers and the foodservice industry. It generates 96% of its revenues within North America.

Its Consumer Products segment produced 38% of 2008 sales. Specific products include plastic waste and food storage bags, aluminum cookware, and foam, paper, plastic, and molded fiber tableware. Hefty, Baggies, and Kordite are among the company’s wellknown brands. Sub-brands include OneZip, EZ Foil, Ultra Flex, Cinch Sak,The Gripper, Kitchen Fresh, Hearty Meals, Elegantware, Zoo Pals, and Easy Grip. The company’s Foodservice/Food Packaging segment accounted for 62% of sales. Customers include processors and distributors, restaurants, cafeterias, and grocery stores. The segment makes tableware, takeout food containers, beverage containers, rigid containers for deli foods and baked goods, microwaveable containers for prepared foods, foam trays for meat and produce, and molded fiber egg cartons.

Roughly 80% of PTV’s products are made from plastic resins such as polystyrene and polyethylene, which are derived from oil and natural gas. Higher costs are passed on to customers, but price adjustments can lag by several months. For example, costs climbed rapidly during the first three quarters of 2008, but prices were slow to follow. When prices were raised, volumes suffered due to the intensifying recession. Net sales grew 9.8% year-over-year in 2008 to $3.57 billion due to higher prices and acquisition-related volume gains, but the gross profit margin shrank 250 basis points to 26.1%. Pro forma net income fell 5.3% to $231 million or $1.75 per share.

Management began 2009 with expectations for lower volumes, yet higher profit margins due to falling costs.

Sure enough, Q1 net sales declined 5.1% year-over-year to $766 million due to lower volume, lower prices, and unfavorable foreign exchange. Consumer sales fell 2.4% to $283 million. Foodservice/Food Packaging sales fell 6.8% to $483 million. Volumes were down, but better than expected.

Better still, lower costs and productivity gains resulted in big margin gains. The gross profit margin improved to 38.25% from 25.99% a year ago. The operating profit margin improved to 21.80% from 11.51%. Pro forma net income jumped 106.8% to $91 million or 69 cents per share. Management expects earnings of 54-58 cents per share in Q2.

Although it expects full year sales to fall 10-12% due to lower prices, per share earnings for 2009 are expected to climb at least 23% to $2.15-2.25. These expectations are a marked improvement over previous guidance.

Nonetheless, bumps in the road remain. For example, due to the recession, consumers have been trading down to cheaper generic products. This trend could worsen as the recession continues. Some consumers may not come back even when the economy improves. In addition, profit margins could get squeezed if plastic resin prices spike. Indeed, the recent increase in crude oil prices is a worrisome development.

Over the long term, growth will depend on the company’s ability to introduce new value-added products. PTV increased expenditures on R&D and promotions, and it just launched the Hefty OneZip Fresh Extend bags, which are designed to keep produce fresher longer. Innovations such as this should appeal to consumers trying to save money.