Equity Research February 16, 2018 U.S. Paper & Packaging Bull/Bear Debates U.S. Paper & Packaging Scott L. Gaffner, CFA +1 212 526 9132 Scott.Gaffnerbarclays BCI, U.S. John R. Dunigan +1 212 526 2607 John.Dunigan2barclays BCI, U.S. Barclays Capital Inc. and/or one of its affiliates does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 26. 2 Table of Contents Page 4: Plastic Packaging Industry Page 5 : Avery Dennison Page 6: Bemis Company Page 7: Berry Global Group Page 8: Sealed Air Page 10-11: Metal Can and Glass Industry Page 12 : Ardagh Page 13 : Ball Corporation Page 14: Crown Holdings Page 15: Owens Illinois Page 16: Silgan Holdings Page 18: Containerboard Industry Page 19: International Paper Page 20: KapStone Page 21: Packaging Corp Page 22: WestRock Co. Page 23: Others Page 24: Sonoco Products Page 25: Veritiv Corp U.S. Paper & Packaging Bull/Bear Debates Sub-sector: Plastics AVY (Top Pick) BMS (OW) BERY (OW) SEE (OW) 3 Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Plastic Packaging Industry Bull/Bear Debate 4 Above average organic growth potential Limited earnings cyclicality Market fragmentation creates M&A optionality Low asset intensity Primary consumer packaged goods markets under pressure Low barriers to entry for new market participants Environmental sustainability is low Bull Case Bear Case Subsector Thesis: Plastic packaging is our preferred sector due to above average growth potential, benefits of falling raw materials prices, and limited earnings cyclicality. Avery Dennison Bull/Bear Debate 5 Multifaceted secular trends driving 4-5% organic growth (e.g. ecommerce/omni-channel marketing, rising middle class in emerging markets, automotive light weighting) Productivity initiatives, material innovation and volume leverage driving margin expansion Scale advantage across segments Strong FCF growth Increasing emerging markets exposure could lead to more volatile returns AVYs dominant position in consolidated markets makes a roll-up M&A strategy difficult, will need to add outside core Industrial & Healthcare Materials has been underfunded for years and may take longer to turn around Bull Case Bear Case OW Thesis: Continued strong organic growth with long term secular tailwinds aided by significant margin expansion should allow for meaningful FCF growth, likely benefitting investors in the form of higher dividends and share repurchases. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Stable end markets with growth driven by substrate conversions, food safety, and growing healthcare needs Scale drives strong cost advantage vs both public and private peers Rising ROIC driven by more disciplined deployment of capital Healthy balance sheet, strong dividend yield, and ability to complete bolt-on acquisitions Portfolio mix is 50% specialty/50% commodity Volume growth has largely disappointed to the downside despite elevated levels of R&D spending Reinvestment into lower margin businesses is necessary to maintain scale High customer concentration Bemis Bull/Bear Debate 6 Bull Case Bear Case OW Thesis: Risk/reward now positively skewed as downside scenario is largely reflected in current share price while upside from self funded turnaround/cost reduction effort hasnt been fully contemplated. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Berry Global Group Bull/Bear Debate 7 Scale creates competitive advantages Acquisition opportunities with proven acumen Limited CPG exposure relative to peers High level of resin pass-through Strategic evolution beginning to be recognized Large % of commodity vs specialty products Elevated hedge fund ownership levels CPG volumes under pressure Bull Case Bear Case OW Thesis: Debt paydown and AEP synergy capture should drive near-term share appreciation, with the long-term opportunity driven by Berrys ability to further consolidate the fragmented plastics industry. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Sealed Air Bull/Bear Debate 8 Razor (10%)/razor blade (90%) model with products skewed to specialties (75%) Long term volume growth driven by fresh/natural food trend, e-commerce, and growth of emerging markets middle class Limited cyclicality and ability to pass-through rising input costs Consolidation of food producers and implementation of zero based budgeting could pressure volumes/margins Thousands of small producers of plastic packaging which could lead to lower than expected organic growth due to share loss SEEs resin purchases lag those of other public peers Uncertainty around new managements go forward strategy Bull Case Bear Case OW Thesis: Strategic shift towards SG&A cost reduction, improved equipment margins, and fungibility of capital deployment between strategic M&A and share repo will lead to improved margins and accelerating total shareholder returns. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Sub-sector: Rigids ARD (EW) BLL(EW) CCK (OW) OI (EW) SLGN (OW) 9 Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Metal Can Industry Bull/Bear Debate 10 Consolidated global supply base Positive secular mix shift from glass to metal cans Long-term supply agreements with near instantaneous cost pass-through Limited cyclicality - long-term, most defensive sub-sector Consolidated customer base Limited pricing power Minimal M&A optionality Margin expansion limited to productivity gains and mix shift Limited cyclicality near-term Bull Case Bear Case Subsector Thesis: Metal Can packaging is the most defensive sub-sector we cover, with high global volume growth (2-3%) and limited price competition due to industry consolidation. Margin expansion limited to productivity gains and product mix shift. Glass Industry Bull/Bear Debate 11 Consolidated supplier base Significant volume leverage Premium consumer preferred product Long-term supply contracts with high level of cost pass through Low growth (0-1% globally) Consolidated customer base Asset intensive Above average earnings cyclicality Cost disadvantage vs alternative substrates Bull Case Bear Case Subsector Thesis: Negative industry dynamics characterized by substrate shift to metal cans and above average earnings cyclicality more than offset the limited price competition, premium product offering and high operating leverage. Ardagh Bull/Bear Debate 12 Glass offering is more cyclical and asset intensive, but provides substrate diversification to beverage can segment High FCF generation with focus on debt deleveraging post-IPO Management is heavily incentivized in the companys success (BoD/management of ARD own 65% equity interest) Highly levered, but not outside norm of past packaging IPOs Limited investor influence due to A/B share class structure Low liquidity due to small size of float Acquisition pipeline constrained due to industry consolidation in developed markets New participant in the beverage can industry Bull Case Bear Case EW Thesis: High quality recession resistant business that is fairly valued at current levels as the repeatability of past growth initiatives (specifically M&A) are limited. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Ball Corporation Bull/Bear Debate 13 Highest quality management team amongst packagers High percentage of revenues coming from beverage can end markets along with above average specialty can mix Long-term attractive FCF potential with proven returns to investors via repurchases Rich 2018 valuation even after recent pullback in shares Synergy realization could be more difficult than expected with limited upside potential High level of customer concentration has and could continue to create choppy results Bull Case Bear Case EW Thesis: Our positive industry view is balanced by our belief that synergy upside surprises for Ball are likely to be limited, and current valuation is stretched. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Crown Holdings Bull/Bear Debate 14 Relative valuation gap to BLL stands near all-time highs Announced acquisition of Signode provides CCK with a high level of FCF generation along with additional growth opportunities that are not yet appreciated by investors Greater flexibility to expand footprint in higher growth emerging markets, increase specialty mix, and/or achieve share gains given #2 position in the market Continued capital expansion despite recent returns below expectations Higher exposure to low growth food can markets Perception of less disciplined management Bull Case Bear Case OW Thesis: Lowest risk proposition for investors interested in the stability and consistent through the cycle FCF characteristics of the beverage can industry. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Owens-Illinois Bull/Bear Debate 15 O-I specific glass packaging end markets estimated to grow 1% annually Management has the capabilities and experience necessary to implement broad manufacturing and commercial changes Asbestos liability has been fully accounted for, reducing uncertainty and therefore making valuation on FCF yield basis more attractive Glass manufacturing is asset intensive and utilizes dated technology that provides little flexibility to changing market conditions Secular share loss to aluminum cans globally High leverage for an asset intensive and cyclical business Bull Case Bear Case EW Thesis: Near-term growth driven by margin improvement via capital projects and better mix of high barrier packaging, but organic volumes remain challenged. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Silgan Bull/Bear Debate 16 Dispensing Systems acquisition creates organic and inorganic opportunities, as well as potential upside to synergy target Inflation protected yield with near instantaneous pass-through of input costs (e.g. real-time pass through of metal costs and 60-90 day pass through of resin costs) Strong customer relationships, majority on long term contracts Low organic growth with volumes across Metals and Closures heavily dependent on impact of weather on seasonal food pack and beverage consumption, respectively Historical M&A strategy becoming increasingly difficult to implement in metals and see little overlap in the Dispensing Systems acquisition with SLGNs core metal can business Continued weak trends in the Plastics business Bull Case Bear Case OW Thesis: 10% FCF yield, through-the-cycle earnings stability along with input cost inflation protection creates a compelling tactical opportunity in the current environment. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Sub-sector: Containerboard IP (UW) KS (EW) PKG (EW) WRK (EW) 17 Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Containerboard Industry Bull/Bear Debate 18 Consolidated supplier base Strong dividend yields Tight supply/demand, rising input costs support higher prices Upside tied to industrial end markets exposure (20%), rising ecommerce demand, and heavy geographic weighting to the US High earnings cyclicality Rising input costs with limited cost pass through Historically low end market growth rates, typically growing in line with GDP High asset intensity Bull Case Bear Case Subsector Thesis: Containerboard is our least preferred subsector due to high earnings cyclicality, near peak margin profile and historically low end market growth rates. International Paper Bull/Bear Debate 19 Industry leader in consolidated markets Emerging Market expansion opportunity High dividend yield (40-50% of FCF) Diversification benefits and synergies from newly-acquired pulp business High exposure to OCC input cost inflation versus peers Large underfunded pension plan Leverage including the pension gap is high for the group and even higher for the containerboard subsector IP and WRK together generate over 50% of industry sales burdening each company with the majority of industry downtime to balance supplydemand Bull Case Bear Case UW Thesis: Elevated valuations, rising input costs, and a large underfunded pension is only partially offset by the containerboard price hikes, a high dividend yield and low cyclicality from IPs diversified business model. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Kapstone Bull/Bear Debate 20 One of the highest exposures to virgin fiber assets, creating a long term, low cost advantage vs peers Organic and inorganic vertical integration opportunities available given relative size in the industry Continuing efforts to de-risk operations and minimize earnings volatility are being realized All-too-frequent operational missteps and mill disruptions that are magnified given KSs smaller scale Distribution business is characterized by lumpy revenue growth, very low margins, and a concentrated customer base Heavily reliant on larger peers to balance supply/demand and push pricing initiatives Bull Case Bear Case EW Thesis: Minimal market share, high exposure to virgin fiber inputs and increasing vertical integration are positives relative to peers, but we think the market is now fairly valuing this reality post WRK bid. Industry view: Positive. Stock rating: OW = Overweight; EW= Equal Weight; UW = Underweight. Packaging Corp. of America Bull/Bear Debate 21 Highest exposure to virgin fiber inputs Highest level of vertical integration in the industry Best-in-class operator with limited market share should allow the company's growth to exceed that of the industry Focus on customer service and value-added products (vs more commoditized boxes) has led to above average volume growth No plans to expand outside the US, limiting scope of growth potential and increasing exposure to US economic cycles Limited product diversity, copy paper sector is secularly declining and PKG is managing for cash Under-utilized balance sheet (average leverage f