O-I Glass: Still Trading At 12-14% FCF Yield Despite A 56% Share Price Increase

Summary

• O-I Glass performed much better than anticipated in the second half of 2022.
• The outlook for 2023 is positive with an anticipated EPS of in excess of $2.50 and an underlying free cash flow result of $450M.
• This means the stock is still cheap based on every metric: EPS, FCF and EV/EBITDA.
• I recently sold a little bit, not because I don't believe in OI's future performance but to take advantage of other opportunities.
• Looking for a helping hand in the market? Members of European Small-Cap Ideas get exclusive ideas and guidance to navigate any climate. Learn More »

thomasmax/iStock via Getty Images

Introduction

About six months ago, in August, I was flabbergasted when I saw the market reaction on what I thought was a pretty decent set of results from O-I Glass (NYSE:OI), the producer of glass containers. The stock fell by more than 10% in a matter of hours and I just couldn’t understand why. I argued in the previous article O-I’s sustaining and growth capex were fully covered by the incoming cash flow and the only reason I could see for the drop was the FY 2022 earnings guidance which implied a Q4 earnings of $0.21-0.36 per share. My main argument was to look through the noise as O-I was executing its transformation plan and fortunately the market caught on. Since that August article was published, the share price of O-I Glass increased by approximately 56% versus the negative 4% return of the S&P 500 (SPY). That’s an outperformance of 60%, a result I would take any moment of the day.

Data by YCharts

The company has now released its full-year results and both the Q4 result as well as the full-year financial results have beat the expectations as the adjusted EPS for FY 2022 came in at $2.30 (which is higher than the $2.05-2.20 guidance provided after the H1 results (which was subsequently hiked to $2.20-2.25) while the Q4 EPS came in at $0.38.

As expected, the company gained momentum throughout the year

This indeed means 2022 was a good year for O-I Glass. Investors shouldn’t look too closely at the income statement as there were a few non-recurring items. As you can see below, there was an ‘other income’ of $299M which really boosted the pre-tax income while the $118M in other expenses weighed on the 2021 results. While the reported EPS of $3.76 looks great, keep in mind it makes more sense to look at the adjusted EPS of $2.30.

OI Investor Relations

That ‘other income’ was generated through the sale of two assets which were sold during 2022 and are thus per definition non-recurring. The properties will be leased back so O-I will see its operating expenses increase from 2023 on but that’s fine as the cash inflow allowed it to further reduce its debt and fund its growth investments.

And that’s fine. As you may remember, my original investment thesis was based on O-I Glass’ ability to generate a positive free cash flow which would subsequently allow it to invest in itself and to keep its debt levels under control.

The total reported operating cash flow for FY 2022 was $154M. but as you can see below, this included a large non-recurring cash payment of $621M to settle the Paddock liability (I discussed this in my previous articles) while there also was a $95M contribution from changes in the working capital position. Adjusted for these two elements while also deducting the $27M in dividends paid to non-controlling interests, the underlying operating cash flow was $653M.

OI Investor Relations

The total capex was $539M which means the underlying free cash flow was $114M. Keep in mind the capex includes growth initiatives (the total capex bill came in more than 50% higher than the depreciation expenses). According to O-I’s recent presentation, approximately $190M was earmarked for strategic and expansion capex, which means the underlying free cash flow exceeded $300M or roughly $2/share.

OI Investor Relations

The image above also shows the outlook for 2023. The EBITDA should increase by more than 10% as O-I is able to continue to push through price hikes, and this should result in an adjusted EPS north of $2.50.

Even more important is the free cash flow. O-I anticipates to generate $150M in reported free cash flow despite spending $700-725M on capital expenditures. As approximately $300M of that capex is related to growth and strategic initiatives, the underlying sustaining capex is just $400-425M which means the underlying sustaining free cash flow will come in at close to, or exceeding $450M which is almost $3/share.

OI Investor Relations

There is one caveat though. The free cash flow guidance provided by O-I Glass includes changes in the working capital position so there may be some additional adjustments to derive the sustaining free cash flow result before changes in the WC position.

And those strategic investments on top of the sustaining capex will be made towards the MAGMA plant which will be commissioned in 2024 and will be the new standard in the glass-making process.

OI Investor Relations

Investment thesis

It’s great to see I was right all along about O-I Glass and the market has finally woken up as well. The stock is trading at just over 8 times this year’s earnings while the underlying free cash flow per share still represents a 12-14% FCF yield (subject to working capital changes). The company will have some debt to refinance in the next few years but I’m not too worried about that: the yield-to-maturity on the existing bonds is only slightly higher than the coupons on those securities so right now, it looks like O-I Glass should not see a substantial increase in its interest expenses this decade. It’s euro-denominated debt may get slightly more expensive but I also anticipate OI to use some of its incoming free cash flow to reduce its gross debt and thus mitigate the impact of potentially slightly higher interest rates.

Although I still see plenty of upside potential, I have taken some cash off the table, mainly because I see plenty of other investment opportunities in these volatile markets.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of OI either through stock ownership, options, or other derivatives. 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.

I sold a portion of my position to diversify, but still have a long position.