S&P likes the food packaging outfit's growth prospects and defensive characteristics, and has a strong buy opinion on the shares
From Standard & Poor's Equity ResearchWe think Crown Holdings (CCK) is poised for continued growth in 2009 and beyond, despite what we expect to be a very weak economy this year. Crown has posted earnings growth over the past two years at a compound annual rate of 19%, and we look for growth of nearly 12% in 2009. As Crown is one of the largest worldwide producers of metal containers used in the food and beverage industry, we think demand for the company's products will remain stable and possibly rise modestly in developed markets in the near term as consumers are likely to eat at home more to save money during difficult economic times. At the same time, Crown should benefit from its strong presence in international markets, where it derives about three-quarters of its sales. The company has recently added capacity in underserved and fast-growing markets in Asia and the Middle East and has plans to continue to expand into these promising markets.
Although the metal container industry is mature in many developed markets, we believe Crown has opportunities for modest expansion in these markets given its technological expertise and emphasis on new product development. We also think the company has some pricing leverage, due to its high market share as well as the low cost of metal packaging relative to the value of the end products it typically contains. Crown expects prices for tin plate to rise significantly in 2009, but we expect the company to raise its prices even more than its costs, which should lead to modest margin expansion.
Crown has relatively high debt levels, but we look for strong cash flows over the next several years to allow for steady debt reduction, even though the company has only minimal debt maturities coming due through 2010.
In our view, Crown shares are attractively valued, recently trading at about 9.9 times our 2009 earnings-per-share forecast. This is below the forward price-earnings valuation of its peer group of packaging companies of 11 times, and we believe the shares should trade at a slight premium because of what we see as the company's solid growth profile, strong market share, and penetration of expanding markets.
The stock, which carries Standard & Poor's highest investment recommendation of 5 STARS (strong buy), recently traded at $19 a share. Our 12-month target price of 25 is based on a weighted blend our discounted cash flow and relative price-earnings analyses.
Crown Holdings (formerly Crown Cork & Seal) is a worldwide leader in the design, manufacture, and sale of packaging products for consumer goods. Crown Holdings has been in business for over 115 years and is one of the oldest U.S. manufacturers. The company's primary products include steel and aluminum cans for food, beverage, household goods, and other consumer products, as well as metal caps and closures. Crown manufactures conventional and easy-open ends for a variety of heat-processed and dry food products including fruits and vegetables, meat, seafood, soups, ready-made meals, infant formula, coffee, and pet food. The company is also one of the largest producers of cans used to package beer and soda. Crown operates about 140 facilities in over 40 countries, and we estimate that more than 75% of its sales came from outside the U.S. in 2008. It has strong market positions in Britain (about 11% of sales), France (9%), and Asia (8%).
The company enjoys strong positions in most of its markets. On a worldwide basis it is the leading producer of food cans and aerosol cans in the world, the second-largest supplier of metal vacuum closures, and the third leading manufacturer of beverage cans. Nearly half of its sales are derived from the large beverage-can market, and about a third comes from food cans. In certain sectors, it has a dominant market share. For food cans, the company has a 42% share of the European market, and in Thailand, it has a 39% share. It also has a very strong market share in most emerging markets, including the Middle East, Vietnam, and Singapore.
The company has a relatively diverse customer base, and the top 10 global customers represented only 28% of its sales in 2007. The customer base includes some of the largest beverage, food, and personal products marketers in the world, including Anheuser-Busch, Coca-Cola (KO), Heineken, PepsiCo (PEP), Campbell Soup (CPB), Gillette, H.J. Heinz (HNZ), Procter & Gamble (PG), and Nestl?. The company's multinational competitors include Ball Corp. (BLL), BWAY Holding (BWY), Impress Holdings, Metal Container, Rexam, and Silgan Holdings. (SLGN).
The company's principal areas of focus include improving operating income, reducing debt, and lowering asbestos-related costs. Generating higher operating income is primarily dependent on Crown's ability to increase revenues and manage costs. Key strategies for expanding sales include targeting geographic markets with strong growth potential, such as the Middle East, Asia, Latin America, and southern and central Europe, improving selling prices in certain product lines and developing innovative packaging products using proprietary technology. Additionally, with what we see as its innovative design capabilities and worldwide production base, Crown has been seeking to capture more business from major international customers who have been consolidating their supplier base. The company's cost-control efforts focus on improving operating efficiencies and managing material and labor costs, including pension and other benefit expenses. The reduction of debt remains a principal strategic goal and is primarily dependent upon the company's ability to generate cash flow from operations. In addition, we believe the company will consider divestitures from time to time, the proceeds of which may be used to reduce debt. Crown seeks to reduce its asbestos-related costs through prudent case management. Asbestos-related payments declined to $26 million in 2007 from $68 million in 2003.
In our opinion, Crown Holdings appears poised to generate solid profitability again in 2009 after recovering in 2007 from several years of subpar results. We think the company has enacted programs that have led to reduced operating and administrative costs, lower interest expense, and a more focused operating plan.
The company is well positioned, in our view, to capitalize on growth in emerging consumer markets around the world. We see sales from continuing operations advancing 3%-5% in 2009, after about a 9% gain expected for 2008. We expect increased unit volume in the beverage can business in Brazil and the Middle East, as well as expanded capacity in Western Europe, Brazil, and Asia, to help comparisons. We think higher prices accounted for 5%-6% of the revenue increase expected for 2008.
After widening moderately in 2008, we think that gross margins will be little changed in 2009. We expect benefits from higher volume and stronger prices to be offset by an unfavorable product mix and a negative currency impact. Although operating margins in 2009 may slip slightly from 2008, they will still be well above historical levels, by our estimates, as the company benefits from efficiency improvements and new low-cost capacity. Our EPS share forecast for 2009 is $1.90, which would represent growth of nearly 12% from our estimate of $1.70 for 2008.
Crown expects to report fourth-quarter 2008 results on Feb. 3, 2009.
The shares have performed well in recent weeks. Over the past two months, the shares have risen nearly 15% vs. a 6% decline for the S&P 500 index. We believe solid stock price appreciation is the result of the company's relatively strong earnings performance and outlook.
We view Crown shares as a defensive holding, since demand for food and beverage items are typically not very cyclical. In fact, during weak economic times, many people eat out less and stay at home, more where they are more likely to consume foods and beverages that are packaged in metal containers. Moreover, the metal and glass container group has done relatively well during weak periods. In the last ten bear markets since 1950, the metal and glass container group has outperformed 70% of the time. (Past performance is not necessarily indicative of future results.)
Our 12-month target price of 25 is derived from a weighted blend of two metrics. Our discounted cash flow model assumes a 9.0% weighted average cost of capital, strong free cash flow growth in 2009, and 3% growth in perpetuity, to derive an intrinsic value of $31. Crown's peer group trades at 11 times our 2009 EPS estimates. Using a modest 5% premium to this multiple (based on our view of better growth prospects for Crown vs. peers) applied to our 2009 EPS forecast, we value the shares at 22. Blending these results, our target price is 25.
In our view, Crown's corporate governance policies are well aligned with shareholders' interests. The board of directors is controlled by a majority of independent outsiders, and the full board is elected annually. The audit, nominating, and compensation committees are composed solely of independent outside directors. Moreover, a simple majority vote of shareholders is required to amend the charter or bylaws and to approve a merger, and directors receive a substantial portion of their compensation in the form of equity.
Risks to our recommendation and target price include an unexpected sharp decline in consumer markets, a rising U.S. dollar, higher interest rates, and a rise in metal costs that exceeds price gains. We expect consumer markets to hold up fairly well during what we expect to be a weak economic period, but, if these markets decline, that would likely hurt demand for Crown's products. With about 75% of its items sold in overseas markets, Crown's profits can be hurt when a rising U.S. dollar leads to a reduced translation of profits into dollars. We note, however, that it is not a large exporter and most of its manufacturing facilities are located near customers.
Crown has fairly high debt levels. Therefore, rising interest rates could lead to higher interest expense. Additionally, we expect metal costs to rise in 2009, but we believe Crown can more than offset these with price increases. If it is unable to do so, margins would likely narrow.