While the market has taken a beating in 2022, there are some names that stand out for outperformance. One name that continues to perform significantly better than the market as a whole is Sonoco Products Company (SON, Financial). Shares of the company have gained 3.1% in 2022, which is remarkably better than the more than 21% decline for the S&P 500 Index.
Despite this relative outperformance, Sonoco Products still trades with low valuation ratios. Combined with a more than 3% dividend yield, the stock could see double-digit return potential if it were to trade closer to its long-term average valuation.
Company background and recent earnings results
Sonoco Products is a leading manufacturer of flexible packaging, rigid plastic containers, paperboard, tubes and cores. The company’s packaging products are used in a variety of end markets, including automotive vehicles, pharmaceuticals, refrigerators and HVAC systems, among others.
Sonoco has been quite aggressive at making acquisitions to bolster its industry-leading position. Most important among these acquisitions is the company’s $1.35 billion purchase of Ball Metalpack, one of the largest manufacturers of sustainable metal packaging for food and household products, at the end of January of this year. Ball Metalpack is also the largest producer of aerosol cans in North America.
The price tag of this purchase is not a trivial amount given that Sonoco Products typically has a market capitalization of approximately $6 billion. On the other hand, the payoff from this transaction has been almost immediate.
The company's most recent earnings results were for the second quarter of 2022 and were released on July 21. Revenue for the quarter surged more than 38% to a record $1.91 billion. Adjusted earnings per share of $1.76 compared quite favorably to $0.84 in the same quarter a year ago. Both revenue and adjusted earnings per share results were higher than analysts’ estimates.
Much of the top- and bottom-line growth was due to the Ball Metalpack acquisition. Following second-quarter results, Sonoco Products raised its guidance for the year, with the company is now expecting adjusted earnings per share of $6.20 to $6.30, up from $5.25 to $5.45 previously. If achieved, this would represent an 76% improvement from the prior year.
Segment breakdown
Acquisitions greatly aided second-quarter results and led to the upward revision of guidance for the remainder of the year, but the base business is seeing solid results as well.
Looking closer at the two main segments of the company, Consumer Packaging grew almost 66% to $990 million. The addition of Ball Metalpack drove a sizeable portion of this growth, but price increases throughout the core business also aided results. Volume growth was mostly solid, led by 4% growth in flexible packaging. North America was down slightly, but this was largely due to supply chain disruptions. These disruptions are not expected to be a long-term issue, so this region could see a return to growth as soon as the next quarter.
Industrial Paper Packaging grew almost 20% to $727.4 million. This marks the eighth straight quarter of growth for this segment. Here again, price realization played a key role in year-over-year growth. Volume and mix were lower by 2%, but was more than offset by higher prices. North America and Latin America experienced growth while Asia and Europe were lower.
All Other, which includes the health care, security packaging and industrial plastic products, was up 11% to $195.9 million. In a recurring theme, this growth stemmed from price increases. Volume was flat.
Not only is revenue growing at a strong rate, profits are growing at a faster rate. Consumer Packaging and Industrial Paper Packing had operating profit improvements of 114% and 57%, respectively, which are well above what revenue growth was for each segment. Ball Metalpack is proving even more valuable on the bottom-line, likely a key reason behind the guidance lift.
As seen in every business segment, Sonoco has been quite successful at passing along higher costs to customers. This is not a one-quarter occurrence either. The company has instituted price increases over at least the four previous quarters as it tried to get ahead of the explosion in raw material costs. Most quarters, volume has remained steady or increased slightly, showing that higher costs aren’t denting demand. This speaks to the need for Sonoco’s products among customers.
Valuation and total return potential
Based on quarterly results, Sonoco’s business is performing very well, but despite this success, the stock is trading at a forward price-earnings ratio of just 9.4 based on the midpoint of estimates for 2022.
According to Value Line, Sonoco has had an average price-earnings ratio of 16.6 for the 2012 to 2021 time period. Much of this period covers a time when there was less uncertainty in the market, so a valuation of this magnitude might not be possible at the present time. However, considering the strength of results and the immediate impact from recent acquisitions, I believe a valuation range of 12 to 14 times earnings estimates could be possible. Using the company's own guidance, this would result in a price target range of $75 to $88, so total return potential could be anywhere in the 27% to 49% range from the share price of $59 as of this writing.
Adding to the total return potential is the stock’s dividend, which is 3.3% presently. This, in the best-case scenario, if Sonoco achieves the top of its guidance for 2022 earnings, the total return potential could be above 50% based on my model. The current yield is slightly above the 10-year average yield of 3.1%.
Sonoco’s dividend growth streak numbers 40 years in length because the company has prudently managed its payments. The last decade has seen a tight payout ratio range of 48% to 55%. Thanks to an accelerated growth rate for earnings per share, the projected ratio is just 31% for 2022. With a larger margin of safety, it is possible that dividend growth could accelerate from the compound annual growth rate of just 4.7% since 2012.
Final thoughts
Sonoco Products has outperformed the S&P 500 this year as the company continues to produce strong results. The addition of Ball Metalpack has been a major positive even at great cost to the company. The ability to raise prices on products without severely impacting volume has also been a tailwind.
The valuation remains very low for the stock given the positives working in its favor, which could lead to substantial total return potential if an improvement in market sentiment were to occur. Sonoco doesn’t even need to reach its long-term average valuation to look undervalued right now in my opinion.
Combined with a solid dividend yield, a long track record of growth and a very low payout ratio, Sonoco Products appears to have all the makings of an excellent value opportunity.
