Silver Ring Value - O-I Glass: Consistently Exceeding Expectations
Summary
- O-I Glass has been consistently exceeding expectations.
- What are some possible concerns by the market that account for a price which still values the company at 7x the low end of expected earnings for this year?
- What are some scenarios I expect to play out over the next few years?
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The following segment was excerpted from this fund letter.
O-I Glass (NYSE:OI)
O-I Glass has been consistently exceeding expectations.
Most recently, management raised EPS guidance for 2023 to a range of $3 to $3.50, up from previous guidance of $2.50+.
What are some possible concerns by the market that account for a price which still values the company at 7x the low end of expected earnings for this year?
- This year’s profits represent a cyclical peak. It is likely that the company is currently earning somewhat above normalized levels, however this is a business with modest cyclicality. For context, organic sales declined about 6% in 2009 and 3% in 2020. My estimate of normalized, mid-cycle EPS is $2.75, placing the stock at less than 9x normalized EPS and Free Cash Flow.
- The company is in a secular decline. While aluminum cans have taken share on a secular basis from glass, primarily in mass-market beer, that trend is a) slow b) has a low likely magnitude of impact going forward given the remaining exposure to the vulnerable segment is a small % of the current business mix. Despite the secular challenges, OI has averaged organic sales growth of 2% over the last decade.
- Capital expenditures are elevated. Management is investing in its new MAGMA technology for smaller, more energy-efficient glass furnaces. It estimates IRRs of close to 20% and has multiyear customer commitments in hand for much of the capacity expansion. The technology has met its milestones thus far, but as with any such endeavor there is always a risk that something goes wrong at a later stage. I estimate that the worst case with respect to this risk is that we lose a year or two of Free Cash Flow and have a business with a low-single digit growth trajectory after that.
- Historical balance sheet and cash flow statements aren’t representative of the current situation and the market still hasn’t caught up. Someone who doesn’t know the business and just looks at historical cash flow will see a very unrepresentative picture. Historically the company had large asbestos-related payments which depressed its Free Cash Flow substantially. Last year the company resolved this issue by bankrupting the relevant subsidiary and settling with the plaintiffs. It has zero asbestos liability remaining and no future payments required. Furthermore, the balance sheet is now at less than 3.5x Debt/EBITDA, which is well below what a business with such low cyclicality is capable of maintaining.
Given the above, I expect one of the following scenarios to play out over the next few years:
- The stock market recognizes the value of the business and the stock re-rates up.
- Fundamentals play out as expected, the market doesn’t recognize the value and the company is taken private by a Private Equity buyer.
- Fundamentals play out as expected, the stock market doesn’t recognize the value of the company, and management begins returning meaningful Free Cash Flow to shareholders. This should begin in 2025 once the period of elevated capital expenditures investment is over.
- I am wrong on the fundamentals either with respect to normalized EPS or to the growth trajectory.
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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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