Global Packaging Sector Quarterly: Cross-Border Megadeals Return; Destocking, Inflationary Pressures Ease in US; Manageable Refi Risk Despite Lower Valuation Multiples; Exceptions Are High-Beta Issuers Ardagh, Kloeckner Pentaplast

Relevant Items:
U.S. Packaging Sector Update April 2024
Ardagh Uptier Exchange April 2024
   

• In this sector update, we highlight the reemergence of cross-border megadeals and the waning of inventory destocking pressure on the sector. Increasing M&A activity likely reflects the generally stable cash flow of the sector, easing inventory destocking and inflationary pressures on consumers, and lower valuation multiples, given sharp increases in funding costs since the end of 2021.
   
• The main price mover among the U.S. packaging names was Ardagh Holdings and the ultimate parent company, Ardagh Finance, after the Apollo uptier transaction announced in mid-April. The transaction pushed out the company’s first maturity until 2026 from 2025, while providing the ability to issue up to another $250 million of exchange bonds for either the Ardagh Holdings senior notes or the Ardagh Finance PIK toggle notes at discounted prices. The ratings agencies downgraded Ardagh after the announcement. We continue to believe the main risk is the company being able to refinance its debt, given sharply higher funding costs.
   
• Across the pond, plastic packaging producer Kloeckner Pentaplast has dominated headlines in recent weeks as the likelihood of a debt restructuring ahead of the 2026 maturity wall is material, despite the company and its sponsor saying otherwise. The first lien debt is, however, relatively safe with minimal risk of being equitized, in Reorg’s view. The company’s financial sponsor, SVP, will remain committed to the asset for multiple reasons, in Reorg’s view.
   
• Among performing credits, we also have a relatively constructive view on the German corrugated board producer Progroup despite the short-term headwinds. Net leverage will rise in 2024 but is likely to decrease in 2025 because of lower capital expenditures and EBITDA growth. The company is also anticipating a return to growth in the short to medium term.
   
• European companies have made the most of the strong demand characterizing primary markets, with Fedrigoni and Guala Closures tapping the market for shareholder remuneration and M&A, respectively. This is despite the lackluster operating environment, illustrated by Verallia’s profit warning and double-digit earnings decline in the first quarter for several companies under our coverage.

 
While Ardagh’s approximately $1.1 billion U.S. dollar-equivalent uptier exchange agreement with Apollo in April was the main news in the packaging sector in the second quarter, M&A announcements have dominated headlines this quarter with a return of cross-border megadeals involving U.S., European and South American companies.

The trend actually kicked off late last year with the Irish-headquartered Smurfit Kappa and the U.S. company WestRock initiating merger talks. The deal was eventually completed in early July based on an enterprise value of about $21 billion. In April, after opposing an offer from Mondi, the U.K. group DS Smith agreed to a deal with U.S.-based International Paper for $9.9 billion, while at the same time the Brazilian company Suzano had eyes on International Paper.

Another large deal announced in recent weeks was the acquisition of Eviosys, a European metal packaging group, by the U.S. packaging group Sonoco for $3.9 billion.
 
In terms of similarities, we note that valuation multiples are relatively similar for the three transactions discussed here. Smurfit Kappa’s acquisition of WestRock was based on equivalent enterprise value to EBITDA multiples of about 7x, while IP’s $9.9 billion transaction values DS Smith at 7.6x. Sonoco’s acquisition of Eviosys is based on a multiple of 7.3x, but this is based on 2024 adjusted EBITDA including synergies.

The financing structures of these deals are different, however, with one entirely equity-funded, one combining both cash and equity, and the last one initially entirely debt-funded.

International Paper’s acquisition of DS Smith will be entirely equity-funded, with DS Smith shareholders obtaining a 33% shareholding in the combined group.

Smurfit Kappa has paid a cash consideration of $1.3 billion to WestRock shareholders alongside offering equity. Immediately following completion, Smurfit Kappa shareholders and WestRock shareholders owned approximately 50.3% and 49.7%, respectively, of the combined group.

This contrasts with Sonoco putting in place a $4 billion bridge facility that it said it expects to refinance with unsecured bonds and a term loan. An equity increase of up to $500 million has also been mentioned, while the term is expected to be eventually repaid with the proceeds from divestments.

Pro forma leverage is expected at 3.6x for Sonoco and 2.3x for Smurfit WestRock. It was not disclosed for International Paper.

Megadeal Rationale and Outlook

While this is certainly not the first wave of consolidation in the industry, this new wave of megadeals may have been driven by the end of the destocking phase, the deceleration of inflation, the plateau reached by interest rates and a less-rigid lending environment. We discussed in our April packaging sector update that operating margins and cash flow have remained remarkably stable over the past several years despite tremendous macroeconomic volatility, with packaging generally remaining one of the most defensive high-yield sectors.

Further, easing destocking and inflationary pressures on consumer spending have brightened the sector’s outlook. However, the impact of higher interest rates has compressed valuation multiples in the sector by about 25% since the end of 2021, as real interest rates have increased by about 300 bps, increasing the sector’s funding costs. The combination of easing sector pressure, in the context of an overall highly stable sector, and sharply lower valuation multiples could well be spurring some of the recent M&A activity.

Also, despite commanding leading market shares in certain products and in some mature markets, M&A continues to be seen as a powerful tool for creating or accelerating growth opportunities for players that might be underrepresented in certain markets, such as Smurfit Kappa in the United States or International Paper in Europe.

The deals also accelerate consolidation in markets that are still immature or fragmented, such as in Latin America.

For Smurfit WestRock, the combination of the two packaging producers appears to be geographically balanced with limited overlap in terms of containerboard production capacities, as illustrated in the slide below. Across 40 countries, the combined Smurfit Westrock company operates 63 paper mills and 500 converting facilities and has 23 million tons of mill capacity worldwide

The combined entity would have market shares of about 20% in the corrugated packaging market in Europe and North America.
 
The key financial metrics of the combined group were disclosed in a presentation discussing the deal:
 
As per International Paper and DS Smith, the diversification benefits, in terms of products and geographies, are shown in the slide below:
 
The key financial metrics and diversification benefits of the Sonoco merger with Eviosys are shown in the chart below:
 
As per outlook, with the impact of destocking on LTM earnings progressively abating, M&A activity could intensify. It could also involve more private equity-owned companies given that their owners are more susceptible in maximizing returns over shorter periods of time compared with company- or family-owned owners.

In addition, megadeals such as those discussed above could push other large companies to look for ways to keep up with changes. The Brazilian pulpmaker Suzano, for instance, initiated talks for acquiring International Paper in an all-cash offer of $15 billion. This offer was, however, conditioned on the termination of the merger with DS Smith. Talks have since terminated.

While megadeals would undoubtedly make headlines, small and medium-sized deals are expected to contribute to the lion’s share of deals as companies desperately try to increase capacities or enter new geographies by acquiring local players, which continue to account for up to 80%, depending on the products, of packaging output.
 
Destocking has been affecting packaging companies for more than two years now, with nearly all companies highlighting that customers have been working down existing inventories as demand from inflation-pressured consumers slowed, which in turn hurt packaging sales.

While destocking originated from the pandemic-era supply-chain adjustments, it had a longer-than-expected impact on many companies.

French glass packaging group Verallia warned about this slow recovery on its full-year earnings earlier this month. Adjusted EBITDA expectations were reduced by about 13% with the group now expecting €866 million, in line with 2022 earnings, instead of €1 billion previously,

The company explained that the anticipated rebound in demand has not materialized as expected despite early signs of improvement in the second quarter of 2024. The market recovery was slower than expected in market demand, the company said. The company said it will provide more details on this financial adjustment during the presentation of its first-half results on Thursday, July 25.

The beer and spirits markets, which account for 12% and 16% of its turnover, respectively, remain relatively sluggish, and selling prices have continued to decline. In the first quarter of the year, sales were down 21% and EBITDA was down 34%. These declines follow a 21% growth in sales in 2023, organically, and a 28% growth in EBITDA.

Italian bottle closures producer Guala Closures also suffered from destocking and negative market conditions with first-quarter sales down 17% and EBITDA down 14%.

In the paper packaging segment, German packaging group Progroup reported a 16% decline in sales in the first quarter with adjusted EBITDA down 58% to €31 million. The company said it was able to increase volumes but prices had a negative impact on earnings. The company added that it anticipates a return to growth in the short to medium term.
 
The credit metrics summary table for all U.S. packaging companies available on Fundamentals by Reorg is shown below:
 
The credit metrics summary table for all European packaging companies available on Fundamentals by Reorg is shown below:
   
Given the high credit quality of most of the U.S. high-yield packaging companies, upcoming maturities do not appear challenging to manage despite the higher funding costs and multiple contraction since the end of 2021. With the exception of Ardagh, loan-to-value ratios remain at very reasonable levels, generally in the 40%-to-50% neighborhood for the BB rated credits and 60%-to-70% area for the B rated credits, again in the context of a highly stable cash flow sector.

Ardagh was able to refinance its 2025 maturity through the Apollo exchange transaction announced in mid-April, but it continues to face a daunting maturity wall in the 2026-’27 period. Our view remains that the Apollo exchange slightly pushed out the maturity wall but did relatively little to reduce the overall refinancing wall, as discussed more fully HERE. Reorg had held a webinar in March and followed with a detailed report in early April discussing the company’s options and flexibility regarding its capital structure.
     
With the exception of Ardagh Holdings and Ardagh Finance, the U.S. packaging credits generally continue to trade in line with the overall index.

The yields offered by U.S. dollar-denominated bonds of packaging issuers, benchmarked against their net leverage, are shown in the chart below. The size of the circle indicates the issue size.
 
In terms of euro-denominated debt, we are relatively constructive on KP’s first lien debt at the current level with the senior secured bonds yielding 11% and trading below 90. The issuer’s total net leverage is high, 8.9x based on adjusted EBITDA as of March 31, and the likelihood of a debt restructuring ahead of the 2026 maturity wall is material, despite the company and its sponsor saying otherwise. However, we view this part of the capital structure as relatively safe with minimal risk of being equitized in a debt restructuring.

The destocking activity, which has crippled the industry for the past 12 to 18 months, is likely to end in 2024. Also, KP is a fundamentally much better company than it was in 2021 as a result of operational restructuring initiatives, a greater focus on recyclable PET products and expansion in the faster-growing U.S. market. We also believe that its sponsor, SVP, will remain committed to the asset for multiple reasons, including the potential equity upside as the group benefits from a cyclical upswing and its ambitious value creation plan.

Last month, Reorg discussed in a webinar the company and its options ahead of the 2026 maturity wall. You can watch the replay HERE and download the slides HERE.

You can find recent analysis on Kloeckner Pentaplast HERE.
 
We also have a relatively constructive view on the German corrugated board producer Progroup given its historically high market margins of 20% to 25% (despite a decline to 15% in 2023), prudent financial policy targeting a long-term net leverage ratio below 3x and a track record of successfully implementing greenfield expansion projects.

The company is facing short-term headwinds, as illustrated by weak first-quarter results (see the financial section), but it is also anticipating a return to growth in the short to medium term. Net leverage will rise in 2024 but is likely to decrease in 2025 because of lower capex and EBITDA growth.

The 2029 and 2031 senior secured bonds are yielding, respectively, 5.2% and 5.5%.

You can find Reorg’s recent primary analysis on Progroup HERE.
       
U.S. high-yield indexes have continued to tighten slightly, with most U.S. packaging credits remaining fairly stable over the last quarter or so. Not surprisingly, the main exception is Ardagh Holdings (ARGID) and Ardagh Finance PIK toggles (ARDFIN) with those tiers of the Ardagh complex downgraded following the announcement of the Apollo transaction.

With respect to European issuers, since their issuance in 2021, KP’s bonds have been relatively volatile with investors seemingly unimpressed by the company’s weak volumes among an industrywide destocking, cost pass-through efforts and the CEO change last year.

In April, KP’s senior notes lost 10 points and fell to the low 40s as news emerged that the company and its sponsor SVP were in talks with PJT Partners on options to address the group’s maturities. The senior secured notes were relatively stable in the low 80s.

The senior notes have since rebounded as Reorg reported that SVP has been buying up the subordinated bonds and accumulated a material stake in the €300 million tranche. They are now quoted at 63 while the senior secured notes are at 88.

Reorg’s recent analysis is HERE. The replay of Reorg’s webinar held on June 27 is HERE. The company’s dashboard is HERE.

Trends in bond prices and spreads are shown in the two charts below. The green lines represent bid and ask prices and the white line shows the midprice, while the orange line and the right-hand axis indicate spreads. Data are sourced from Solve.
 
Following the announcement of its acquisition by Sonoco Products Co. for €3.6 billion, Eviosys’ bonds jumped to the 101 area, a level they have not been trading at since early 2022. In the last two years, the €125 million dividend paid in 2022 and the €400 million dividend recap in 2023 highlighted a shareholder-friendly financial policy.

Trends in bond prices and spreads are shown in the chart below. The green lines represent bid and ask prices and the white line shows the midprice, while the orange line and the right-hand axis indicate spreads. Data are sourced from Solve.
 
Eviosys, also known as Titan, was Crown Holdings’ former EMEA food and consumer packaging business. It was acquired by KPS Capital Partners in 2021. Since then, EBITDA significantly improved, with margins reaching about 17% in 2023 from 13.8% in 2021 and an average of 12% between 2018 and 2020.

Reorg’s primary preview on the €400 million term loan B is HERE. The company’s dashboard is HERE.

Following the opposite path is Pro-Gest’s €250 million senior unsecured bonds, which are now quoted in the 32 area, down from the mid-50s at the beginning of the year.

Pro-Gest had not approved its consolidated financial statements for the year ended Dec. 31, 2023, by the end of April 30, citing its current financial situation, ongoing discussions with its primary financial creditors and the “reshaping and refocusing of the group’s industrial and financial plans” that are currently underway. Chief Restructuring Officer Sergio Iasi resigned from his position on the company’s board after four months in the role. A default event has now occurred after missing its interest payment.

Trends in bond prices and spreads are shown in the chart below. The green lines represent bid and ask prices and the white line shows the midprice, while the orange line and the right-hand axis indicate spreads. Data are sourced from Solve.
 
Reorg’s update on the creditor talks is HERE. Our asset sale analysis is HERE. The company’s dashboard is HERE.

Lastly, Guala Closures’ senior secured floating-rate notes have lost a couple of points, from 95 to 93, as the Italian bottle closures producer’s rating was downgraded to B by S&P Global Ratings and to B2 by Moody’s Investors Service following the debt-funded acquisition of Astir, an established manufacturer of crown closures headquartered in Athens, for an enterprise value of about €136 million. The proposed transaction will see net leverage rise to 4.2x from 3.5x.

This transaction, in Reorg’s view, illustrates the company and its sponsor’s aggressive financial strategy. The issuance leaves leverage well above the soft target range of 3x to 3.5x discussed back in October 2023.

Trends in bond prices and spreads are shown in the chart below. The green lines represent bid and ask prices and the white line shows the midprice, while the orange line and the right-hand axis indicate spreads. Data are sourced from Solve.
 
Reorg’s primary analysis on the last bond issuance is HERE. The company’s dashboard is HERE.
   
With respect to primary market transactions, the U.S. packaging credits have been fairly quiet in the past few months, with certain credits refinancing 2025-’26 bonds with similar 2029-’32 bonds.

Italian paper and label manufacturer Fedrigoni was in the market for a second time this year issuing €730 million worth of notes in aggregate, including €300 million of PIK notes. Proceeds will be used primarily to redeem 2027 notes and to repay vendor notes issued to affiliates of Bain Capital.

The senior secured notes priced at 6.25% while the PIK notes priced with an initial interest rate of 10% a year to the extent interest is paid in cash and 10.75% to the extent the payment is deferred. Reorg’s analysis of Fedrigoni’s senior secured notes issued in January is HERE. The legal analysis is HERE.

Guala Closures priced a €150 million floating-rate note tap at 100.5. Investors considering the tap said that the company’s performance has softened over recent quarters because of a challenging environment characterized by customer destocking, which is expected to continue to some extent in the second quarter. However, these are temporary impacts and fundamentally the company is strong, most buy-siders agreed. Reorg’s analysis of the issuance is HERE.

Norwegian paper producer Norske Skog has retired all of its euro-denominated bond debt after it issued a 1.4 billion Norwegian kroner (about $130.9 million) five-year senior unsecured bond with a coupon of NIBOR+4.5% to refinance its existing €150 million senior secured bonds and fund general corporate purposes.
 
In the last quarter, Silgan Holdings was upgraded by Moody’s to Ba2 from Ba3, while as noted in the price movers section, all of the agencies downgraded Ardagh following its Apollo financing in mid-April, which allows additional exchange notes to be issued for either Ardagh Holdings senior notes or Ardagh Finance PIK toggle notes at discounted prices.

As highlighted in the “Price Movers” section, Guala Closures rating was downgraded to B by S&P and to B2 by Moody’s following the debt-funded acquisition of Astir for an enterprise value of about €136 million. The debt-funded acquisition will see net leverage rise to 4.2x from 3.5x.

After missing an interest payment in June, Pro-Gest was downgraded to Caa3 and SD by Moody’s and S&P, respectively.

Reorg’s latest U.S. credit rating monthly report is HERE and latest EMEA report HERE.