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Unwrapping value in packaging debt

Hermes Credit

Home / Perspectives / Hermes: unwrapping value in packaging debt

Andrey Kuznetsov, CFA, Hermes Senior Analyst
28 September 2016
Credit

High valuations and low prospective returns may deter some credit investors from the global packaging sector. However our search for relative-value opportunities has compelled us to look beyond labels to find the attractive corporate instruments inside.

Valuations in the global packaging industry seem expensive relative to history, and recent performance has been strong: spreads are well below those of the index for three- and 10-year periods. This can be partly explained by a decline in M&A as the sector becomes increasingly consolidated and the credit profiles
of larger issuers improve. Nevertheless, we have found opportunities in the sector.

Figure 1. Relative performance of the packaging sector

packaging-chart1

Source: Hermes, Bloomberg as at Q3 2016.

Material differences
Traditionally a defensive sector, packaging has generally tracked global GDP growth. We expect this historical trend to continue but understand that structural changes in the industry have led to a divergence in performance between different regions and sub-sectors.

Growth in packaging demand in developed countries such as the US is likely to remain low – at or slightly below GDP – while continuing to surge in emerging markets as middle-class consumer habits become entrenched. However, demand growth in these countries will be more volatile than in the long-established, higher-margin packaging sectors in developed regions.

Rapidly changing consumer preferences across the world are also impacting demand for packaging materials such as plastics, container board, metal and glass. For instance, the fastest-growing end markets, pharmaceuticals and cosmetics, use plastics intensively. However, this growth is partially offset by greater M&A and low barriers to entry compared to the glass and metal packaging sectors. Credit investors should not overlook these more mature and stable markets.

Figure 2. Market concentration by regionpackaging-table

Source: Hermes Credit, Credit Suisse as at Q3 2015.

Ardagh Group: why the glass is more than half-full
After making 22 acquisitions in the last 17 years – the latest being the $3.1bn purchase of metal-packaging assets during the merger of Ball and Rexam in 2016 – Ardagh Group is well positioned to benefit from its global presence, scale and strong relations with customers.

The company’s management team has a strong track record of generating enterprise value by buying companies at prices lower than what public-market valuation multiples would imply. From these transactions, it has created synergies through best-practice operations and superior procurement of raw materials. As a result, we are optimistic about the company’s ability to improve profitability after the integration of its latest acquisition is complete.

We believe that Ardagh’s unsecured bonds are well covered based on current market multiples in the packaging sector. The company has also issued a good amount of payment-in-kind (PIK) instruments that sit below the unsecured bonds in its capital structure, which would be the first credit instruments to absorb losses if the company became stressed.

Ardagh's capital structure includes euro- and dollar-denominated secured and unsecured bonds, PIK notes and credit-default swaps (CDS). We prefer the euro unsecured notes because they offer an attractive pick-up from the secured instruments and CDS, and better cross-currency adjusted spread than the dollar-denominated notes.

We expect Ardagh’s dominance in its markets, combined with its ability to derive benefits from the integration of Ball and Rexam and potential to reduce leverage, to lead to an improved credit profile for the company. This provides an attractive package for investors.

Figure 3. Ardagh's unsecured notes: cushioned by equity and PIK instruments 

packaging-chart3V2

Source: Hermes as at Q3 2016.

Past performance is not a reliable indicator of future results and targets are not guaranteed.  This article does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments. The value of investments and income from them may go down as well as up, and you may not get back the original amount invested.

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Andrey Kuznetsov CFA, Hermes Senior Analyst Andrey joined Hermes in 2013 as a credit analyst. Prior to this he was a credit analyst for a multi-strategy credit fund at BCM & Partners LLP, a London-based boutique asset manager. Previously, he worked in various roles in Russia and China. Andrey graduated with a master’s degree in Management from London Business School and holds a degree in Economics from State University – Higher School of Economics in Moscow, where he majored in Financial Engineering and Mandarin Chinese. Andrey is a CFA charterholder.
Read all articles by Andrey Kuznetsov

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