Sonoco Products Stock: Selloff Is Overdone, Buy To Lock In 4.2% Yield (NYSE:SON)

bunhill/E+ via Getty Images With markets currently sitting at all-time highs, it may be prudent to increase allocations to defensive sectors like consumer staples, health care and utilities. One of the challenges with the consumer staples segment is picking the right brand or product category. Sonoco Products Company (NYSE:SON) is a packaging supplier to many of the leader consumer products companies around the globe. Why not get broad exposure to consumer staples without the risk of choosing a single brand or category while collecting a growing dividend and 4.2% yield? Recently, the shares have sold off from a high of $61.50 to just under $50 on news that the company is acquiring Eviosys, a private equity owned company that was acquired from Crown Holdings (CCK) in 2021. I think the selloff is too steep, and the shares offer a compelling valuation. Company Overview Sonoco has been an innovator in packaging technology for 125 years and as a proof point, they have received over 500 patents just since 2020. The company produces four categories of packaging, and they focus on the segment of the broader packaging industry that is considered value-add. This means that they are not just a raw material paper supplier or steel producer, which are relatively more prone to commodity price cycles. Sonoco 2024 Investor Day Presentation After the close of the Eviosys acquisition, the combined company will generate about $9.2 billion in revenue. Rigid paper containers will constitute about 16% of revenue, metal packaging 38%, flexibles and thermoforming 14%, and industrial paper packaging 27%. The remaining 5% is “other” and is a variety of packaging materials including plastic, paper, foam, and various other specialty materials. Why The Market Is Sour On Eviosys Acquisition The selloff in SON shares actually started prior to the acquisition announcement, so we can’t attribute all of the downturn to this. That said, shares opened -2.3% on the day of the announcement (June 24th) and traded as low as -5.7%. They’ve continued to drift lower to where they are now down about -10.6% since the acquisition news. Clearly, the market does not like the deal, and we need to understand why. Sonoco is paying $3.9 billion and funding it via the sale of $2.7 billion in new bonds, issuance of $500 million of common equity and a $700 million term loan. Management also communicated that they will be raising $1 billion of cash from divesting non-core businesses, including the Thermosafe business. Depending on the timing of the sale of these businesses, management said that they may not need the $700 million term loan, but that even if they do, they expect to pay it off in 3 months. Sonoco – Eviosys M&A Call Presentation More debt and share dilution (the bad) Looking at the new capital structure (after the acquisition and the divestitures) we see that SON will carry 3.6X net debt to EBITDA. The common share count will also increase from 98.3 million to about 109 million (assumes 10 million shares sold at $50 per share for proceeds of $500 million). I also wonder if the market is skeptical of the strategic rationale for this purchase. While Eviosys does add scale in metal packaging when combined with the metal can business that SON bought from Ball in 2022, would it have been better to find an acquisition in the rigid paper packaging market where management says that the long-term growth rate is higher (see above graphic)? Accretive to earnings, cash flow, and no impact to investment grade rating (the good) Management’s strategic case for the acquisition is that it will create a more focused company better able to serve global customers and weighted more heavily towards consumer-oriented end markets (~70%). Financially, they project that the combined company will generate higher EBITDA margins of 17% or more (from ~16% today). Accretive by 25% to consensus 2025 EPS based on $100 million of cost synergies and increase of $350MM free cash flow in 2025. On the M&A call, the CFO confirmed that the EPS forecast includes the impact of the share dilution. Moody’s and S&P confirm IG rating on close and forecast is that leverage ratio will be under 3.0X in 24 months post close. Notably, the CFO believes that the cost of debt on the new bonds will be in the vicinity of 4.5% (+/-) aided by the fact that they will be euro-denominated, and they will hedge some of the offering. The $100 million synergy goal is very conservative in my opinion. Management indicated that a large portion of it will come from enhanced purchasing power and procurement savings, especially in the large steel spend. Compelling Valuation And Dividend Record The “new” Sonoco will primarily (81% of revenue) be a metal container and paperboard/rigid paper manufacturer. As such, I’ve built a set of peers using the comparison tool on Seeking Alpa that you can access here. Sonoco trades at… Lowest forward P/E on a GAAP EPS basis Second-lowest forward EV/EBITDA Lowest Price/Cash Flow TTM Seeking Alpha Comparison The valuation discount is not justified by poor performance. Sonoco is in the middle to upper half of the pack on profitability metrics, with a clear path towards hitting 17%+ EBITDA margins. Seeking Alpha Comparison In years past shares have generally traded for over 10 times cash flow with the exception of the pandemic period in 2020 to early 2021. The long-run average for the industry seems to hover around 7 to 8 times cash flow. Seeking Alpha Charting At this depressed valuation, you are paid to wait for operating results to continue improving while collecting a 4.2% dividend yield. Sonoco is the king of dividends in its industry. At the current share price, the dividend yield is higher than where it has been during 96% of the past twenty years. I like that management has expressly declared that the “dividend is foundational” and that they believe it drives discipline and creates shareholder value. Better yet, 99 years of paying a dividend and 41 years of increasing it bring serious credibility to these statements. Koyfin Percentile Rank Dataset Over those 41 years, the dividend has increased at just over 10% compounded annually. While I don’t expect that the dividend can continue growing at that rate, I do think a 4% growth rate is very achievable, and it is just a tad lower than the growth rate over the past 5 years. The global population is projected to increase from 7.6 billion to 9.8 billion by 2050 or about 1% annually. Combine population growth with inflation of around 3% and real economic growth on top of that and a 4% dividend growth rate seems conservative. Growth Outlook To 2028 The stock price probably does not show much improvement until management delivers on their goals for the acquisition, namely paying down the debt and increasing operating margins, as well as showing in-line or better revenue growth. I think management has done a good job streamlining the business, having shed some non-core operations (like timber lands) and reorganizing from +20 business units to the current 4 core ones. At the 2024 Investor Day, management outlined a plan to increase adjusted EBITDA by about 40% to $1.5 billion by 2028. The previously communicated target of $1.5 billion in EBITDA will be revised upward with the acquisition to about $1.9 billion. The plan to achieve the higher margins is built on investments in automation, bringing regional back-office shared services into one global center and reducing the number of ERP systems from six to three. Looking out to 2028, I think the company can earn $760 million and with 109 million shares that translates to EPS of $6.92. Only one analyst on the street provides a 2028 forecast, and it is at $7.44 GAAP EPS. With some improvement in the PE multiple to 12 to 15 times, shares could rise to between $83 and $104. Without any valuation multiple expansion, we still pocket the dividend yield and earnings growth. Signs Of Selloff Is Nearing The End The question is whether this is a value trap or is the floor in for the share price and thus presenting a good entry point? One indication that the floor may be in or that we are near it is that a large institutional buyer seems to have bought the stock on the Friday before the acquisition announcement (which is a little fishy, perhaps). Shares were trading down through a key support level at $56 all day, and then in the last hour volume surged, driving the shares back up over $1 before the close. TradingView.com This pattern of buying in the last 30 minutes of the trading day has continued the past week and I think the shares are stabilizing between $48 and $50 where support has rested in the past too. Risks And Flags We need to watch and see where the cost of debt for the upcoming bond sale prices. If it lands higher than the mid 4% range and/or the company does not maintain its investment grade rating, it is a sign of doubt from the credit market and would definitely impair the stock price. There is also a risk that the company is unable to achieve at least $1 billion in proceeds from divestitures of non-core businesses, thus impacting the ability and timing for the company to pay off the $700 million term loan. Right now, the mergers & acquisitions market is fair, in my opinion, and deals are getting done. That could change quickly with a market selloff and if investors move to a risk off sentiment. Third, while company revenues are geared towards consumer staples end-markets, it is categorized in the materials sector for the market, which is generally viewed as procyclical. Any downturn in the economy could cause broad-based selling of materials stocks, and Sonoco shares could get dragged further down and not benefit from a rotation into consumer staples and other defensive sectors. Conclusion This is a stock for value investors or those who want to rotate into a consumer staples supply chain for defensive reasons given the market conditions right now. It’s not often that you get to buy a company that has been paying a dividend for nearly 100 years and continues to increase the dividend for 41 years and counting at a compelling valuation. It’s also a company that seems to have a reasonably good culture, and my experience is that you don’t last for 125 years if you don’t treat people well. I like their motto: “People build businesses by doing the right things”.

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