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Morningstar | Sonoco Hits Rough Patch in Consumer Packaging, Offset by Favorable Price/Cost in Paper

As we had expected, Sonoco continued to benefit from relatively low old corrugated container, or OCC, prices and tight paper paperboard and containerboard markets. However, Sonoco's third quarter came with weakness in its consumer segment as operational challenges and unfavorable mix weighed on segment income. In what seems like a wise strategic move, the company also finally exited a packing contract that had weighed on displaying and packaging results for more than a year. With our long-term forecasts unchanged, our $41 per share fair value estimate and no-moat rating are intact.

Sonoco's paper business saw margins decline sequentially, mostly due to the impact of Hurricane Florence. Relatively low input prices (OCC) and favorable finished product prices have supported margins well above historical norms for the company. It's our view that today's favorable economics will eventually give way as competitors increase supply of boxboard and containerboard products. In turn, this will drag segment margins lower by 2%-3% from current levels above 10% over the coming five years. In our view, this level of profitability would be more reasonable, given the commoditylike nature of the business model.

In Sonoco's consumer business, margins and segment income weakened more than we had expected. While higher freight and resin costs have been a persistent headwind in packaging, Sonoco noted unfavorable mix and weakness in key composite can categories--one of the company's signature products. Ultimately, it's too early to tell whether this is anything more than transitory. Over time, we think Sonoco will gradually lift operating margins from roughly 9.9% in 2018 to around 10.4% in 2022, consistent with management's long-term goal of 10%-12%.