Seeking Alpha

Sonoco: The Slight Pullback Is Not Enough

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About: Sonoco Products Company (SON), Includes: WRK
by: AllStarTrader
Summary

A recent pullback Sonoco shares should not be met with enthusiasm yet.

Sonoco Products Company is more diversified than peers but trades at a premium valuation.

Investors can still find higher yields, lower valuations, and higher upside elsewhere in the sector.

Third quarter results were still not worthy of a premium valuation.

Image result for sonoco packaging

Source

Sonoco Products Company (NYSE:SON) operates in the consumer packaging and goods space. It is a dividend aristocrat that can be counted on year after year to raise its payout in good times or bad. Investors like the company for its smaller market capitalization compared to peers and its diversified product offerings. While the company faces larger more well-capitalized peers, it offers stronger growth due to its product offerings. However, much of this appears to be priced in as the valuation trades at levels quite a bit higher than peers. This is despite the fact that the growth in the most recent quarter was less than inspiring. We review where shares would become an attractive investment and what peers offer better value.

Performance

Sonoco recently reported and it missed on revenue slightly while beating earnings estimated.

Source: Seeking Alpha

While I consider this miss negligible, it is the decline in revenues that appeared to be less than attractive. Furthermore, the company reported adjusted earnings per share that was the same as the year prior.

Source: Earnings Slides

While net income saw growth, it was primarily due to a lower effective tax rate and lower S&A expenses. The company did, however, narrow guidance lower for the year to $3.50 to $3.54 from $3.52 to $3.62 per share. This represents roughly 14% growth at the midpoint of the guidance over 2018 earnings.

The company has also seen a significant decline in cash flow for the year.

Source: Earnings Slides

There was, however, a $200 million dollar pension contribution voluntarily, which affected cash flow. While that is a positive to reduce pension liabilities, it is worrisome that the company is only going to see $60-80 million in free cash now for the year.

Looking at each division individually, we see that almost every divisions saw a decline and only one saw growth.

Source: Earnings Slides

Consumer packaging, the largest division, saw a decline in revenue and margins. This is what diversified the company among peers in the sector. What is interesting is that the Paper and industrial products saw revenue growth of 6.9%, which helped make up for the decline in the display and packaging segment as well as protective solutions. This division is what competitors primarily operate in, which has been weak of late.

Looking at the company's balance sheet, we can see that debt increased, but debt/capital stayed steady.

Source: Earnings Slides

Being an economically-sensitive company, I would prefer to see debt levels come down. The company could see a major decline in a recession due to the consumer packaging division, which makes up the largest segment of sales. While the diversity in divisions ultimately helps protect from any impact in one sector, the company is overly exposed to the healthy consumer. Ultimately, expensive packaging is cut back on when costs need to be lowered.

The company benefits from the fact that most of its sales are generated in North America.

Source: Investor Presentation

Because of this, the company has not been overly exposed to currency headwinds or the slowdown in the global economy. While the company cites sluggishness worldwide, it is clear it is not dependent upon global sales to succeed.

The company continues to focus on new packaging ideas as a way to drive further sales growth as well.

Source: Investor Presentation

The growth in prepared foods, meals, and home delivery food kits has been a big help in contributing to the company's success. The company needs to continue to focus on these categories to separate itself from the competition which produces general goods in the packaging space. These items are usually easily copied, low margin, and heavily price competitive. However, the company should offer these items, nonetheless, as they can be used by the same customers already purchasing packaging. This would create synergies and cross-selling opportunities.

Valuation

While there are not many direct peers, there are several who operate in the packaging space in general. The valuations compared to Sonoco seem quite low.

Chart Data by YCharts

Sonoco is quite different than these peers but it operates in a similar environment with similar customers. The closest competitor Bemis was recently acquired by an Australian competitor making us unable to compare. While the others operate primarily in corrugated cardboard, similar to the company's industrial offerings. These operators, however, do have consumer packaging and do benefit or feel pain the same way Sonoco does in a rising or declining economy. As we can see, Sonoco trades at a higher forward P/E and P/S and has a lower yield than most in the sector.

Looking at the historical valuation for the last 5 years, we can see if Sonoco shares trade at premium or discount to their own average.

Source: Morningstar

The shares currently trade at a higher P/CF, P/S, P/B, and PEG than it has for the last half-decade. This implies to me shares certainly don't offer value and may even be overpriced. I prefer to look at a company that is trading at a discount to their own history while operating fundamentally well.

Looking at the historical yield, we can further see if shares offer an opportunity for investors looking to capture a higher-than-average yield.

Source: YieldChart

In the last 24 years, the shares have had an average yield of 3.2%. Currently, the yield 2.97% is signaling at perhaps overvaluation yet again. While the company has raised its dividend for 36 years, the most recent raise of 5% signals a slow-growing dividend that won't be playing catch-up to its average. An enterprising investor would look to an entry point of $52 or less for an above-average yield. This is precisely where I would begin to find shares attractive as well. At these levels, they would begin to offer a slight discount to their 5-year average.

Conclusion

While any company who can raise their dividend 36 years in a row should be praised, an investment still has to make sense. Purchasing shares of Sonoco would be a nice addition to any portfolio at the right price. However, for now, shares seem to be too expensive. The company should be able to continue to grow its revenue outside of an economic recession. The adoption of recyclable packaging and more flex packaging for new consumer goods should continue to support its portfolio of product offerings. Right now, there are more attractive ways to play the space for the patient enterprising investor. I have begun to invest in WestRock (WRK) as it offers a lower valuation and higher yield than average. If Sonoco shares were to pull back 10%, I would begin to become interested in adding the company to my portfolio.

Disclosure: I am/we are long WRK. 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.