Eye on Owens-Illinois

| About: Owens-Illinois, Inc. (OI)

Owens-Illinois (NYSE:OI) is the world’s largest supplier of glass containers used for bottling beer, wine, liquor, tea, juice, food, and pharmaceuticals. Major U.S. customers include Anheuser-Busch (NYSE:BUD), SABMiller (OTCPK:SBMRY), Molson Coors (NYSE:TAP), Diageo (NYSE:DEO), PepsiCo (NYSE:PEP), H.J. Heinz (HNZ), and Novartis (NYSE:NVS). Large customers outside the U.S. include InBev (INBVF.PK), Heineken (HINKY.PK), Foster’s (OTC:FBRWY), and Scottish & Newcastle (SNCWF.PK).

Starting this year, OI reports operating results for four geographic segments. Europe, the largest, produced 44% of 2007 sales. North America generated 30%, South America produced 13%, and Asia Pacific accounted for 12%. The remaining 1% consists of unallocated revenues. Glass containers offer several advantages over alternatives such as aluminum and plastic. They preserve purity and flavor, they are infinitely recyclable, and there is no shortage of raw materials. Glass is also cost-efficient for the customer, which is particularly important in developing countries where containers are often reused and refilled 30-50 times before being recycled.

OI hired a new CEO in December 2006 and quickly announced plans to explore strategic options for its plastics packaging business. In 2007, the company sold the business, which accounted for 10% of net sales, for $1.8 billion. OI used the proceeds to reduce its debt load to $3.7 billion. It also took a $115 million non-cash charge to boost asbestos liability reserves to $455 million. OI has about 14,000 pending asbestos-related lawsuits and claims, down from 19,000 in 2006.

At the risk of lower volumes, management adopted a strategy of raising prices in an effort to improve profitability. It also restructured global operations by reducing manufacturing capacity in Europe and North America. These initiatives progressed faster than expected and the pro forma operating profit margin expanded 369 basis points in 2007 to 13.59%.

Net sales grew 13.8% to $7.57 billion, thanks to higher prices, greater volumes, a more favorable sales mix, and currency gains. Sales in Europe and North American grew 15.9% and 7.6%, respectively, to $3.3 billion and $2.3 billion. South American sales grew 21.9% to $971 million and Asia Pacific saw a 16.1% increase to $934 million. The company’s effective tax rate fell to to 24.4% from 40.3% in the prior year.

Pro forma net income jumped to $493.7 million or $2.94 per share, from $173.2 million or 98 cents per share in 2006. Risks remain despite OI’s promising outlook. For example, asbestos liability reserves may prove insufficient to cover all future claims. Unanticipated developments in pending cases may force the company to increase reserves again.

Furthermore, price increase may depress volumes more than anticipated. OI is even susceptible to weather conditions because unusually cool temperatures can reduce demand for bottled beverages. OI’s global operational review and restructuring activities will continue through the beginning of 2009. These initiatives should offset any near term input cost inflation.

Furthermore, as of the end of 2007, OI had hedged 50% of its projected 2008 North American natural gas requirements. As a result, further price increases that are already planned should boost profit margins. Customers appear willing to absorb higher prices because they recognize the value glass containers offer. Glass is also more eco-friendly than other materials, which could cause demand to rise as more consumers become environmentally conscious.