Berry Plastics: Buy The Products Or The Stock?

| About: Berry Plastics (BERY)
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Imagine a customer list including household names like Dannon, Dean Foods (NYSE:DF), ConAgra (NYSE:CAG), Kraft (KRFT), Kroger (NYSE:KR), Unilever (NYSE:UL), Hardee's, McDonald's (NYSE:MCD), Starbucks (NASDAQ:SBUX), Subway, Wendy's (NYSE:WEN), Yum! (NYSE:YUM), Wal-Mart (NYSE:WMT), McCormick (NYSE:MKC), Bayer, Coca-Cola (NYSE:KO), Shell Oil, Johnson & Johnson (NYSE:JNJ), PepsiCo (NYSE:PEP), Wyeth (owned by Pfizer (NYSE:PFE)), Sherwin-Williams (NYSE:SHW), S.C. Johnson, Perrigo (NASDAQ:PRGO), CVS (NYSE:CVS), Target (NYSE:TGT), L'Oreal, Avon (NYSE:AVP), Tyco Electronics (TYC), Home Depot (NYSE:HD), True Value, Ace, Costco (NASDAQ:COST), Kimberly-Clark (NYSE:KMB) and Procter & Gamble (NYSE:PG). In fact, imagine a customer list with over 13,000 business names. Factor in a respectable degree of customization for each customer making the prospect of that customer abandoning the business relationship expensive. It could even be substantiated that this company can well be the difference between a consumer's purchase of its customers' products or not. That's a company definitely worth a second look for a long-term investor.

Berry Plastics (NYSE:BERY) began trading on the NYSE in October 2012. But, the company has been in business since 1967. Berry provides plastic consumer-packaging and engineered materials. It operates in four segments: Rigid Open Top, Rigid Closed Top, Engineered Materials and Flexible Packaging. Revenue is spread somewhat evenly across the four segments at $1.2 billion, $1.4 billion, $1.4 billion and $700 million respectively (based on the trailing twelve months). As well, no single customer represents more than 3% of revenue. According to the 2012 annual report, even the top ten customers represent only 17% of revenue. Products include containers, closures, bottles, prescription vials, tubes, drink cups, plates, bowls, pitchers, flowerpots, closures, overcaps, spouts, spice containers, tapes, stretch films, foodservice films, liners, drop cloths, trash bags, and the like. Custom solutions for medical applications, anti-corrosion applications, the oil and gas industry and the construction industry are niche markets.

Key to its operations are a vast product library of proprietary and customer-specific molds, patents, and technologies. Besides production, Berry offers conceptual design, graphic arts services and a full roster of decorating options including all types of labeling, hot-stamping and screen printing. The breadth and depth of its services are what would make switching suppliers difficult, time-consuming and costly for its customers. Still, Berry prides itself on staying on the forefront of technology for the benefit of its customers. It also strives to minimize costs for its customers by such activities as being a major purchaser of raw materials and by employing packing technologies to minimize shipping and warehousing costs. Berry recognizes that packaging is a significant value-add to consumer products relative to form, function and branding. Demands in the industry include brand recognition, improvement in safety and convenience, new and improved functionality, barrier protection, thermal management, incorporation of track-and-trace technology and environmental friendliness.

According to The Deal Pipeline, the packaging industry raked in $670 billion in 2010 and is expected to grow to $820 billion by 2016. Of the 2010 total, 40% or $274 billion went to plastics. As evidence of the growth of the plastics segment of the packaging industry, in 2005, plastics represented 30% of the industry and in 2006, 34%. The whole industry has been in a consolidation stage for some time, starting with a record year in 2006. In 2011, there were 114 merger and acquisition transactions in the industry. Earlier this month, five packaging companies in North America and Europe merged to form the sixth largest packaging company in the world. Attractive candidates for acquisition typically offer new technology or solutions to a niche market or expansion into a new locality.

Berry does 93% of its business domestically from over 80 locations in the United States. The majority of locations are a result of acquisition. In 24 years, Berry acquired 35 companies, including 12 since 2006. And, as a result, it has manufacturing facilities in Mexico, India, the Netherlands and Belgium, Germany, Australia, Brazil and Malaysia. During the first quarter of 2013, Berry made its first capital investment in Brazil.

Packaging is primarily a local process. Empty containers are not usually shipped internationally. So, Berry set further international growth as a short-term goal. Its focus is on high-GDP-growth areas such as Latin America, Asia and Brazil. However, it is tracking well behind the world's largest plastics-packaging company, Australian-based Amcor, with a $12 billion market cap and 300 operations sites in 42 countries. Competitors Sonoco Products (NYSE:SON) with 347 sites in 34 countries and Sealed Air (NYSE:SEE) with 145 sites in 62 countries are also well ahead of Berry relative to international presence.

With a well-established domestic business and reputation and a possibility of international growth, there are compelling reasons to stock up on Berry Plastics. Analysts have given Berry one of the largest estimates for long-term growth in the industry at 17.33%. Berry claims to outpace all its competitors regarding EBITDA margins at 17.4%.

Yet, Berry has a looming and haunting challenge - debt. With only $16 million in cash and $4 billion in long-term debt, Berry carries the risk of not being able to expand through acquisition. It does have borrowing capacity of $518 million but the ability to incur additional debt could be limited. Cash flow must be first directed to its indebtedness. For 2013, Berry budgeted $230 million for new products, organic growth and international expansion.

To its credit, Berry has reducing leverage as one of its four key initiatives. In February, Berry refinanced some of its debt to decrease annual interest expense which resulted in credit ratings upgrades. In the six months between its fiscal year-end in September 2012 and second quarter reporting in March 2013, it decreased its debt obligation by over 10%. But, to rely on that as a trend is unsettling when one reviews the past few years' performance. In three of the last 5 years (2008, 2010, 2011), Berry incurred an annual loss. The profit in 2012 was just $3 million or $0.02 per share.

It's not that the packaging industry tends to be debt-free and Berry Plastics, alone, has a challenge. Rather the industry, on average, carries a long-term debt to equity ratio of well over 100 at 137. By definition, the higher the ratio, the more risky the stock. Some experts recommend caution when the calculation results in a ratio over 40. Considering Berry has negative shareholder equity just makes the situation even more worrisome.

There is no denying that Berry's customer list impressively attracts investment interest. There's also no denying its debt and recent losses have the ability to depressively repel interest. If that same debt level impairs its ability to expand organically or internationally, Berry's growth potential could be repressed. Until that debt level decreases, long-term investors leery of risk should probably just buy the products rather than the stock.

Disclosure: I am long PG, YUM. 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.

Additional disclosure: I belong to an investment club that owns shares in PG and YUM.