Morningstar | Sonoco's Margins Climb on Declining Recycled Paper Prices; Maintaining our $41 FVE
Sonoco notched a solid second quarter, as adjusted EPS increased 31% year on year to $0.92. While we were impressed by the performance of both the consumer packaging and protective solutions segments, the largest growth (80% of the increase in adjusted segment income) came from Sonoco's industrial paper segment as input costs remained low and prices, high.Although we've slightly increased our near-term outlook to reflect an increase in management's profit guidance for the year, we remain bearish on the long-term outlook for North American linerboard and medium prices. As competition intensifies amid today's highly favorable economics, pricing and margins should recede. Accordingly, we think the industrial paper segment's 13% operating margin in the second quarter will mark near-peak profitability. We think the market is overestimating long-term profits for the industrial paper segment and we reiterate our $41 per share fair value estimate for no-moat Sonoco. The stock currently trades at $55 per share, roughly 35% above our fair value estimate.
The consumer packaging business grew sales 18% year on year, with management calling out especially good performance in composite can sales in both Europe and Asia--likely supported by elevated production volumes ahead of the World Cup. However, we think management's guidance for a slowdown in volume growth going forward is likely to play out as consumer packaged goods companies continue to struggle to gain traction with customers.
A long-awaited highlight during the second quarter was an improvement in protective solution operating profit margins. Margins expanded 2.2% year on year to 10.3% in the quarter as productivity initiatives and increased prices took hold. While segment results could prove choppy from quarter to quarter, the business should be able to generate margins above 10% over the long term. This is due to a number of niche products in the protective solutions segment that include temperature assured medical packaging and vehicle light-weighting components. These products tend to command higher prices and greater profits.
Sonoco Products is a manufacturer of industrial and consumer packaging products and a provider of packaging services. The company's segments are: Consumer Packaging, which includes round composite cans, shaped rigid paperboard containers, fiber and plastic caulk/adhesive tubes, aluminum, steel and peelable membrane easy-open closures for composite and metal cans; Paper and Industrial Converted Products, which include recycled paperboard, chipboard, tubeboard, lightweight corestock, boxboard, linerboard, corrugating medium, edgeboard, paper grades, and adhesives; Display and Packaging, which include point-of-purchase displays; and Protective Solutions, which include packaging and components.
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