I first discovered Berry Global Group, Inc.NYSE:BERRY) in 2021 while screening for high-quality growth stocks. Berry performed incredibly well for revenue growth and above average for revenue growth. The company is a cash flow car.
I remember the stock looking cheap from a P/E perspective, trading at less than 10x. At first I thought I found a diamond in the rough and got really excited.
Unfortunately, that changed after diving into Berry’s balance sheet and cash flow statement, and after listening to the company’s latest earnings call at the time.
What I learned was that Berry liked to rack up debt and didn’t seem that concerned with creating shareholder value. Berry’s market cap today is $7.4 billion, the same as in 2017.
Fast forward to today, and everything has changed. In this article, I will review why I think Berry Global is at the beginning of a turnaround that is likely to unlock meaningful value for patient shareholders.
Reader Summary Summary
In short, the company manufactures and sells packaging products (primarily plastic) to multiple industries, including: health and beauty, food and beverage, and medicine and pharmaceuticals.
In my opinion, Berry’s trades are quite diversified and countercyclical. Meaning, regardless of the macroeconomic environment, Berry will likely come through it largely unscathed.
Not to say that the company would not be affected by a widespread recession; she will. But I think it would weather the storm better than most because of its broad customer base and diverse product mix.
Until recently, leadership at Berry was concerned with growing the company through acquisitions, meaning the large and growing amount of debt on the balance sheet. Berry was less concerned with driving organic growth (ie increasing revenue and profits in the markets it already served), or creating shareholder value.
In 2020, the frustrations of activist investors finally gave way due to a prolonged disparity between Berry’s share price (relative to its peers) and its financial performance.
What did the activists see?
These 3 companies have combined earnings extremely well over the past 10 years and shareholders have been rewarded handsomely.
But would you believe me if I told you that Berry surpassed them all? Well, it’s true.
How can a company, after growing FCF and earnings by +15% for 10 years, have a 5-year average P/E of 10x? That’s the question activist investors should be asking themselves in 2020.
Feeling pressure from activist investors and shareholders in general, Berry took concrete and measured steps to unlock shareholder value. As of early 2022, some of these include:
- Appointing a new CEO, Kevin Kwilinski
- Appointment of 3 new members to the Board of Directors, including a partner in Canyon Partners (one of the activist investors)
- Major halt/withdrawal of M&A activity
- Aggressively paying down debt to reduce net leverage to less than 3.5x, which it expects to meet by end-2024
- The institution of a quarterly dividend, which currently yields 1.67%
- Repurchase of shares in a timely manner
In my view, Berry has shifted her priorities from “growth at all costs” to “unlocking long-term shareholder value.” This is particularly evident in Q4 2023 and full year earnings presentation. There are slide after slide documenting Berry’s shareholder-focused priorities, which is very encouraging.
But words are fluff. Fortunately, Berry’s actions are not. IN 2022, Berry returned $709 million to shareholders through share buybacks. The trend continued in 2023, with $728 million returned to shareholders through a combination of stock buybacks and dividends.
Incidentally, this was not Berry’s capital allocation strategy for the previous 10 years, as evidenced by the cash flow statement. Notice how the company slightly diluted its dividend-free stockholders from 2014 to 2021? The last 2 years are a big change. To me, this shows that the turnaround effort is real.
Berry’s stock is up 18% since its fourth-quarter 2023 earnings announcement at a current price near $63 a share. Even with the upside, the stock still looks undervalued.
Berry’s non-GAAP forward P/E stands at 8.3x, compared to its 5-year average of 10.2x. For 2024, the non-GAAP EPS consensus is $7.71. Assuming a reversion to the mean driven by improved market sentiment due to Berry’s turnaround effortswhich places a fair value at $78.64 ($7.71 x 10.2x) representing a 25% undervaluation.
Similarly, the market is pricing in declining FCF growth over the next 10 years. This is based on an inverse DCF calculation. For the calculation, I assumed a 12% discount rate and terminal P/FCF of 10x.
At $63 per share, The implied FCF growth rate is -2.4% per year. Remember, Berry has grown FCF at 15% CAGR the previous 10 years. The market appears to be extremely low with low expectations for Berry. With the bar so low, it seems like a possibility.
The case of the bear
Berry is a plastic manufacturer, which in light of the ESG movement, comes with a negative connotation. Environmentalists argue that plastic is bad for the health of the planet and humanity. And with increasing pressure to invest in green, environmentally friendly companies with strong ESG initiatives, institutional investors may shy away from a plastics producer like Berry Global.
To unlock shareholder value, Berry needs big-money, institutional investors to drive the stock’s valuation. Unless Berry can convince the institutions that it’s an eco-friendly, sustainability-focused company (which I believe it is), no amount of dividends or share buybacks will move the needle on market cap.
Fortunately, Berry’s new CEO Kevin Kwilinski is focused on just that, sustainability, as evidenced in his fourth quarter 2023 earnings call:
I would say, thoughts about growth and opportunity, we’ve owned a very large opportunity around sustainability. And this is not theoretical, because the reality of the world we are in is — Europe is far ahead of us. And we’re operating in Europe — and we’re seeing where the legislation is going and the opportunities it creates for new types of highly recyclable — high recyclable content, advanced recycling containing plastic products that consumers want to fit within extended manufacturer’s responsibilities and reversible, reusable options. And they drive very large opportunities for growth and profit shares if we have products that are superior and differentiated.
Berry’s story is no longer about growth, it’s about execution and profitability. I don’t expect double-digit revenue growth year after year. But 5-10% organic EPS growth driven by product innovation and operating efficiencies, coupled with 5-10% growth via share repurchases, creates a compelling opportunity. Not to mention the new dividend.
There is an inherent risk associated with Berry due to its core business as a plastics manufacturer, but management is focused on the environment and sustainability. I think it’s worth taking a risk.
Plus, the market is sour on Berry, pricing the stock well below its historical valuation multiple and expecting no FCF growth over the next decade. With such a low bar, it sure seems easy to jump.