By The Valuentum Team
Dispensing-pump maker Aptar (NYSE:ATR) is doing a lot of things right across its three business segments, but we like its exposure to the Pharma business most -- it accounts for ~30% of sales on ~35% EBITDA margins. The company's performance in its two other verticals, Beauty + Home (~55% of sales) and Food + Beverage (~15% of sales), aren't bad either, with each posting EBITDA margins in the teens. We like that Aptar continues to invest to drive innovation and product differentiation, allocating ~3% to research and development annually. The company's dispensing solutions typically grow faster than the overall packing industry.
There's not a lot that we think will derail Aptar's business, which traces its origins to the late 1940s. Most of its business is tied to the beauty, personal care, and prescription drug markets, and we don't expect these verticals to experience significant disruptions anytime soon. Raw material costs (plastic resin, rubber) are worth watching closely. Net debt stood at ~$300 million at the end of 2015, but free cash flow remains robust, averaging ~$155 million per annum during the past three years (2013-2015), more than double run-rate annual cash dividend obligations. 2015 marked the company's 22nd consecutive year of paying an increased dividend, and we expect growth in the payout to continue, which should help build the yield to more competitive levels compared to the current ~1.5%. Let's dig deeper.
Aptar's Investment Considerations
• Aptar is a leading global supplier of a broad range of innovative dispensing systems for the fragrance/cosmetic, personal care, pharmaceutical, household and food/beverage markets. Its delivery solutions include aerosol valves, nasal pumps, and lotion dispensers, among others. The company was founded in 1992 and is based in northern Illinois
• Aptar is #1 or #2 in the markets in which it serves. No competitor fully matches the firm's broad product offering, geographic presence, and the number of markets served. We think its position as a leader in the dispensing solutions niche of the packaging industry is quite advantageous.
• Aptar's strategy is to invest meaningfully in R&D at a pace of about 3% of sales, make key acquisitions of well-managed companies with unique technology, and expand close to its customers. The company has expertise in design and prototyping, precision injection molding and high-speed assembly of creative solutions.
• Aptar has a number of drivers for achieving its growth targets. It is aiming to maintain market share leadership in its key applications, grow its market applications where it is not already a leader, and expand its presence in Asia. Color cosmetics, home care and hair care in Asia present material growth opportunities for the firm.
• Aptar's dividend continues to advance at a nice clip, and its cash-flow-derived Dividend Cushion ratio is north of 2. The firm continues to return additional cash to shareholders via share buybacks as well.
Economic Profit Analysis
From our point of view, the best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital with its weighted average cost of capital.
The gap or difference between ROIC and WACC is called the firm's economic profit spread. Aptar's 3-year historical return on invested capital (without goodwill) is 18.6%, which is above the estimate of its cost of capital of 9.9%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT.
In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid gray line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Aptar's free cash flow margin has averaged about 6.2% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG.
The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Aptar, cash flow from operations increased about 14% from levels registered two years ago, while capital expenditures fell about 2% over the same time period.
We think Aptar is worth $66 per share with a fair value range of $51-$81.
The margin of safety around our fair value estimate is derived from an evaluation of the historical volatility of key valuation drivers and a future assessment of them. Our near-term operating forecasts, including revenue and earnings, do not differ much from consensus estimates or management guidance. Our model reflects a compound annual revenue growth rate of 4.8% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of -0.2%.
Our model reflects a 5-year projected average operating margin of 15.1%, which is above Aptar's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 3.4% for the next 15 years and 3% in perpetuity. For Aptar, we use a 9.9% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $66 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.
Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph above, we show this probable range of fair values for Aptar. We think the firm is attractive below $51 per share (the green line), but quite expensive above $81 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Aptar's fair value at this point in time to be about $66 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of Aptar's expected equity value per share over the next three years, assuming our long-term projections prove accurate.
The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change.
The expected fair value of $86 per share in Year 3 represents our existing fair value per share of $66 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.