Description

Silgan (SLGN)

This is a write up for a defensive equity idea.

Executive Summary:

Silgan operates in the packaging industry serving global consumer packaged goods customers. The business has a long history of deploying capital through M&A and returning excess capital to shareholders in the form of dividends and buybacks when M&A does not offer acceptable returns. Silgan consistently produces high single digit adjusted pre-tax return on assets and with the help of leverage translates into pre-tax returns on equity in the 30’s. Insiders own ~23% of the business.  

Like most competitors in the packaged goods industry, Silgan experienced a slowdown in demand from customers managing their inventory and weakness in Europe (international sales are ~23% of sales). Inventory corrections are annoying however like all inventory corrections typically result in a restocking period in the future. Given the disappointing results Silgan is currently ~20% off its highs, which is historically an attractive entry point which LDD future returns.

With 2023 free cash flow guidance of ~$375 million Silgan offers a levered equity free cash flow yield of 7.6% with a highly defensible business.

What I expect:

• Headwinds will fade
  • Customer Inventory Management – “while consume demand remained resilient, several of our customers were initiating internal working capital and inventory management initiatives for the second half of 2023”
  • This will dampen results for 2H 2023. The Company guided 2023 adjusted EPS down from $3.95 - $4.15 to a range of $3.40 - $3.60. More than half of the guide down was attributable to customers inventory management.
• Operational excellence
  • Silgan paused its “rationalization” charges in 2020 and 2021 due to a surge in demand. These rationalization expenses are set to resume with Silgan matching supply to customers needs and reducing its higher cost facilities. I expect the company will protect its bottom line through cost cutting maintaining its stable operating margins.

Risks

• General Macro
  • A recession could further impair Silgan’s business, but its end markets are less volatile consumer goods.
• Interest Rates
  • Silgan $4.2 billion of gross debt of which 56% is fixed (excluding interest rate hedges). As interest rates move higher it will eat up more free cash flow. Given the working capital dynamics of Silgan’s business (working capital builds Q1-Q3 and releases in Q4) leverage builds during the year and falls in Q4. Silgan finances its working capital needs through its revolving loans.
  • Excluding the revolving loans Silgan gross leverage ratio is ~3.7x on 2023 estimated EBITDA. Target leverage is 2.5x to 3.5x. Silgan expect to generate ~$375 million of Free cash flow which can be used to reduce debt.  
  • 
• European energy
  • Silgan added a new risk factor in its 2022 10-k highlighting the cost and access to energy specifically for its European operations.
• Customer Concentration
  • Three largest customers (Nestle, Campbell Soup, and Del Monte) accounted for 23.7% of Silgan’s revenue in 2022.

History

Silgan was founded by R. Philip Silver and D. Greg Horrigan in 1987. The business began via M&A acquiring Nestle’s metal container division and Monsanto’s plastic container business in 1987. M&A continued to be a crucial growth driver for the Company. Below is a history of Silgan’s acquisitions.

Today, Silgan operates 112 manufacturing facilities in 21 different countries.

Dispensing and Specialty Closures

• Revenue CAGR (’03 to ’22) 13.5% representing ~36% of total revenue.
• Contracts include a pass through for raw material costs

Metal Containers

• Revenue CAGR (’87 to ’22) 7.6% representing ~53% of total revenue.
• Contracts are long term with direct pass through for steel and aluminum

Customer Containers

• Revenue CAGR (’87 to ’22) 6.2% representing ~11% of total revenue.
• Contracts are long term with raw material pass through.

Drawdown Chart

Buying Silgan when it first drawdowns 20% typically generates attractive CAGR’s. Note these returns are in the midst of the current ~20% drawdown.

Valuation

• P/E – NTM ~13x (below 8-year average)
• EV/EBITDA – NTM ~9.5x (in line with 8-year average)

Other

• Investor Relations Presentation

DISCLAIMER: This does not constitute a recommendation to buy or sell this stock. We may or may not have a position in this company, and we may buy shares or sell shares at any time.

Catalyst

It is a requirement to have something here. This is a defensive idea in a quality business whose equity has historically performed well after a 20% drawdown in the stock price. So there is that.