November 13, 2014 - 1:04am EST by
2014 2015
Price: 73.00 EPS 4.79 5.39
Shares Out. (in M): 100 P/E 15.2 13.5
Market Cap (in $M): 7,280 P/FCF 12.1 10.8
Net Debt (in $M): 2,230 EBIT 908 1,034
TEV ($): 9,510 TEV/EBIT 10.5 9.2

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  • Manufacturer
  • Cardboard
  • Potential MLP
  • Industry Consolidation
  • Rational Pricing
  • Packaging



Packaging Corp. of America ("PKG") is the 4th largest manufacturer of containerboard and corrugated products (cardboard boxes) in North America. Basic stats: $7.3b market cap, $9.5b TEV, 10.5x 2014 EBITDA - Maint. Capex and 8% 2014 Maint. Free Cash Flow Yield.

  • Attractive industry - The containerboard industry has gone through significant consolidation in the last several years. The 4 largest players now control ~75% of the market. The industry is characterized by rising prices, stable (and cyclically depressed) volumes, and consistently high operating rates
  • Clear path to industry-leading earnings growth - We estimate 10%+ annual EBITDA growth from $1.1b in 2014 to $1.4b in 2016 
    • PKG has a strong track record of taking market share
    • PKG acquired Boise in October 2013 for 4.3x EBITDA post-synergies. PKG expects "at least $175m" of synergies, most of which have not yet been realized
    • In October 2014, PKG converted an old newsprint machine ("D3") to produce containerboard; PKG spent $115m to generate $60m of incremental EBITDA -> 1.9x EBITDA (highly accretive)
  • Attractive absolute and relative valuation - PKG trades at 8% 2014 Maint. Free Cash Flow Yield, growing to 11% by 2016; it trades in-line with its publicly traded comps on both levered and unlevered multiples, despite superior earnings growth and higher margins
  • Industry actively exploring an MLP structure, and PKG is the best positioned - We believe the production of containerboard from virgin fiber qualifies for MLP treatment. PKG is the best positioned to take advantage of this structure given (1) highest exposure to virgin capacity, (2) superior organic growth profile. Due to low cost capital and importance of distribution growth, an MLP within the industry creates incentive for further industry consolidation

At 10x 2016 EBITDA - Capex, PKG is worth $102 / share, ~40% upside in ~1.25 years. If PKG creates an MLP structure, we estimate PKG is worth $122+, 67%+ upside.

Investment Thesis

Attractive industry

  • After several mergers, the industry is now highly consolidated with top 4 players controlling ~75% share
    • Current industry structure: International Paper 32%, Rock-Tenn 20%, Georgia-Pacific 11%, Packaging Corp. 10%, Kapstone 7%
    • In 2000, top 4 players controlled 49%
    • Significant recent mergers: IP acquired Temple-Inland (2012), Rock-Tenn acquired Smurfit-Stone (2011), IP acquired Weyerhaeuser (2008)
  • Industry behaves rationally
    • IP and Rock-Tenn take downtime to control supply / demand balance
    • Containerboard prices have steadily risen over time at a 6% CAGR since 2006
    • Industry generally runs at 92% - 100% capacity utilization; currently at ~98%
  • Industry volumes are currently ~360 billion SF, which is relatively flat since 2010, but cyclically depressed versus a long-term average of ~388 billion SF (pre-2008)
  • All of the major containerboard producers have significant exposure to virgin fiber capacity, which is cost-advantaged vs. recycled containerboard (“old corrugated container” or “OCC”)
    • It is prohibitively expensive to build a new virgin mill from an environmental permitting and cost perspective, so new capacity uses recycled fiber
    • In the short-term recycled fiber prices are volatile, but in the long-term recycled fiber costs should increase (fiber can only be recycled 7x) -> recycled capacity will continue to be the marginal high cost producer

PKG has a track record of taking market share

  • Since 1997, PKG has grown volumes 55% (40% organic); during the same period, industry box volumes declined 7%
  • We attribute market share gains to PKG's focus on local / regional customers, IP and Rock-Tenn controlling supply to maintain industry pricing, and superior execution

Synergies from Boise and D3 conversion expected to add at least $155m in EBITDA by 2016

  • In October 2013, PKG acquired Boise for $2b at 6.8x EBITDA (4.3x w/ $175m in synergies)
    • $175m of synergies likely conservative, as guidance has increased from $105m to “at least $175m”
    • ~$80m expected to be realized in 2014 -> “at least” $95m in incremental synergies to be realized beyond 2014
  • In October 2014, PKG converted a Boise newsprint machines (“D3”) to containerboard. The economics are compelling: $115m investment to produce $60M of incremental EBITDA -> 1.9x EBITDA
    • We note that the Company has a strong record of pursuing and completing high ROIC capex projects (Counce / Valdosta energy projects in 2010/2011, for example)

Attractive absolute and relative valuation

  • Trades at 10.5x 2014 EBITDA - Maint Capex, and 8% Maint. FCF yield
  • Trades at 8.2x our 2016 EBITDA - Capex estimate
    • EBITDA to grow from $1.15b in 2014 to $1.4b in 2016 ($155m from Boise/D3 + $100m from organic growth)
    • Assumes $250m of maintenance capex
    • Implies $7.75 / share of FCF in 2016 (11% yield)
  • At 10x 2016 EBITDA - Capex, shares are worth $102, ~40% upside before any value from an MLP structure
  • Attractive relative valuation – Based on 2014 EBITDA - Maint Capex, PKG trades at 10.5x vs 10x for the comps (IP, Rock-Tenn, and Kapstone). PKG has highest growth profile and industry-leading margins

Industry is actively exploring an MLP structure, and PKG is the best positioned

  • A Master Limited Partnership (“MLP”) is a tax pass-through entity for income derived from the exploration, development, mining or production, processing, refining, transportation or marketing of any mineral or natural resource. We believe the conversion of virgin fiber into containerboard qualifies for MLP status
  • The Company can be thought of as 2 different businesses
    • (1) Mills that convert virgin fiber into containerboard
    • (2) Box plants that convert containerboard into corrugated boxes
    • Business (1) could be structured as an MLP that sells containerboard to business (2)
  • All publicly traded comps have announced they are actively exploring a MLP structure. Rock-Tenn and Kapstone have filed private letter rulings (PLR) to the IRS, while IP and PKG are preparing to do so
  • PKG appears to be very interested in the structure
    • “We spend a lot of time on this and we have a good appreciation of its merits, both financially and strategically”
    • “Our ability to redeploy assets should resonate well with any potential MLP investors and this can create a lot of value for both the MLP investors and the PCA shareholders”
    • “We’ve engaged legal and financial assistance to provide the information that will allow us to submit a request to the IRS for a Private Letter Ruling
    • “As Mark said, we’ve engaged auditors, legal and other advisers to look at what we would need to do for setting up the initial MLP IPO for carve-out audited financials
  • We believe PKG is best positioned in the industry to take advantage of the MLP structure due to (1) highest exposure to virgin mill capacity, (2) industry-leading organic growth profile
    • PKG’s mill capacity is 74% virgin, whereas KS is 65%, IP is 63% and RKT is 55%
  • Due to low-cost capital and incentive to create accretion, we believe an MLP at either PKG or a competitor would create more incentive for further industry consolidation
  • The value creation from an MLP is dependent on many assumptions, but we estimate the MLP can add $20+ / share in value, 27%+ of today’s share price. This implies $122+ / share of total value, or 67%+ upside
    • In a reasonable end state of the MLP, we estimate PKG could allocate 60%+ of EBITDA into an MLP, employ 4.5x leverage, and trade at a 6.5% dividend yield
    • Based on extensive work and conversations with leading tax experts, we believe there are multiple strategies that can be used to minimize, defer, and potentially avoid tax leakage
    • However, our estimate use conservative tax leakage assumptions
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Realization of Boise synergies

Incremental EBITDA from D3 conversion

New high ROIC capex projects

Creation of a MLP at the Company or competitor

Further industry consolidation

Free cash flow generation

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