By The Valuentum Team
2016 marked packaging giant Bemis' (NYSE:BMS) 33rd consecutive annual dividend increase as it retains its spot on the enviable list of Dividend Aristocrats. Innovation and new packaging launches will remain core for the firm, and expansion in Latin America and Asia present new opportunities. The company is working diligently to drive operating margin expansion across its 'US' and 'Global' packaging operations, the former to the high teens from ~14% in 2015. Bemis has a 15% ROIC hurdle-rate, levels that imply economic value generation. We assign the company an attractive Economic Castle rating (see here).
Operating cash flow remains robust at Bemis, and the company just set a record in that department in 2015 (~$550 million). Certainly, competition is fierce, but we think Bemis has carved out a rather nice packaging niche. The company has been working to reduce long-term debt, but it is still rather lofty at ~$1.35 billion at the end of 2015; net debt to adjusted EBITDA was 2.4x as of March 2016. Free cash flow has averaged ~$240 million during the past five years (2011- 2015), in excess of its yearly run-rate of cash dividend obligations (~$110 million), but capex has marched steadily higher over this time.
Though we aren't expecting to see much that will have management willingly put its dividend reputation on the chopping block, we do think the firm's best dividend growth years are behind it, partly because of its leverage. It currently registers a less-than desirable 0.5 Dividend Cushion ratio, and while its dividend yield is above-average at ~2.3%, we generally prefer companies that have significantly net-cash-rich balance sheets, something Bemis does not have. All else equal, dividend-paying equities with gobs of cash on the books are in much better financial shape to grow the payout than those that do not. That's our biggest beef with Bemis, but it's not a tragic one.
Bemis' Investment Considerations
• Bemis makes flexible packaging products and pressure sensitive materials for the food industry. It has a strong technical foundation in polymer chemistry, film extrusion, coating/laminating, and adhesive technology. Though the market in which the company sells its products is highly competitive, it has been a leader since 1858.
• Bemis' unique film structures are used for complex packaging, which serves as a competitive advantage. Less complex packages are more susceptible to competition and new entrants.
• Bemis' long-term target for return on sales in the US packaging market is 15%-18% return on sales by 2019, up from 14.3% in 2015. Its target for adjusted return on sales in the global packaging market is 10%+ by 2019, up from 8.8% in 2015. Margin improvements will be driven by innovation, productivity and efficiency, and pricing analytics.
• We like Bemis' disciplined capital stewardship. The firm has 30+ consecutive years of increasing dividend payments and remains laser-focused on funding organic expansion. Cash flow from operations has been consistently strong through the course of the economic cycle.
• Management's outlook for 2016 includes adjusted diluted earnings per share to be in the range of $2.68- $2.78 per share, in-line with our forecasts. Capex for the year is expected to be approximately $200 million.
Economic Profit Analysis
In our opinion, 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. Bemis' 3-year historical return on invested capital (without goodwill) is 13.6%, which is above the estimate of its cost of capital of 9.5%. As such, we assign the firm a ValueCreation™ rating of GOOD.
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 grey 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. Bemis' free cash flow margin has averaged about 5.1% 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 Bemis, cash flow from operations increased about 49% from levels registered two years ago, while capital expenditures expanded about 57% over the same time period.
We think Bemis is worth $43 per share with a fair value range of $34-$52.
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 2.7% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of -7.5%.
Our model reflects a 5-year projected average operating margin of 12.6%, which is above Bemis' trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 2.5% for the next 15 years and 3% in perpetuity. For Bemis, we use a 9.5% 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 $43 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 Bemis. We think the firm is attractive below $34 per share (the green line), but quite expensive above $52 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 Bemis' fair value at this point in time to be about $43 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 Bemis' 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 $55 per share in Year 3 represents our existing fair value per share of $43 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.