Lowered credit ratings and shrinking profit margins have some analysts thinking that the packaging sector could use a make-over right about now.
The slumping economy has hammered packaging firms, many of which are suffering from heavy debt loads from their aggressive acquisition strategies in the 1990s. Two significant examples are competing blow molders in the food, beverage and personal-care container market: Graham Packaging Co. LP and Crown Cork & Seal Co. Inc.
"Graham and Crown are just two out of about 20 companies that are in a cash liquidity squeeze," said packaging analyst and consultant Timothy Burns of Cranial Capital Inc. in Williamsville, N.Y.
"We've got basically a slowdown in sales and earnings growth, and highly leveraged companies who all of the sudden are running a little low on cash flow," Burns said.
Graham is majority owned by Blackstone Group LP, a private, New York-based investment firm that bought Graham in a leveraged buyout in 1998. Graham had planned to pay off a big chunk of its debt through an initial public stock offering last year but dropped the plan when the stock market slumped.
York, Pa.-based Graham lost $12.1 million in the quarter ended Nov. 30, the most recent figures available, and from 1999 to 2000 saw its interest expenses increase $12.2 million, to $76 million, according to Securities and Exchange Commission documents.
Philadelphia-based plastic- and metal-container producer Crown Cork already is publicly traded, and its share price tumbled last month when the company reported a loss of $237 million in the quarter ended Dec. 31.
Graham and Crown Cork officials did not return telephone calls seeking comment.
Both firms have grown through aggressive domestic and foreign expansions and acquisitions since the mid-1990s. The benchmark deal for Crown Cork was the 1995 purchase of Paris-based packaging giant CarnaudMetalbox and its 175 worldwide plants, which made Crown Cork the largest packaging company in the world.
Three years later, Graham purchased five CarnaudMetalbox plants for $44.4 million.
Because of what he considers Graham's strong management and customer relations history, Joel Tiss, senior vice president of equity research at Lehman Bros. Inc., is inclined to see Graham's situation as temporary and easily fixed over time, with some adjustments.
"Investors really love [Graham's] management team, even if everything is not going perfectly smooth," Tiss said from his New York office. "Crown is the complete opposite. Crown has basically been in denial for four years about how tough their operating environment has been.
"That's hurt investor confidence in the company a little."
Burns takes that idea a step further, arguing that investors have lost interest in all packaging stocks — which is in part to blame for Graham's failed IPO.
Burns said the $200 million Graham hoped to raise through the IPO could have been used to pay down the company's debt.
"The bottom line is, packaging stocks continue to be really an area where investors don't care," he said. "The performance has been so bad in general that most money managers and investors aren't really excited to step up."
Both analysts say Blackstone will be pressured to come up with the cash to rescue its investment — for which it probably paid too much.
Both Burns and Tiss think the packaging industry is being hurt by overcapacity.
"Three things have to happen," Burns said. "First, there should be a capital expenditure moratorium. Second, every competitor should look at their system and shut down the highest-cost assets that aren't cost-effective.
"Third, we need three years of 3-3.5 percent general price increases to get margins and cash-flow returns back to where they were in the mid-1990s."
Tiss thinks other changes are in order. For instance, shifting focus away from single-digit-growth soft-drink segments toward double-digit custom PET would be a helpful start.
"We need people to take capacity out — specifically, the capacity has to come out of the soft-drink side and not the custom PET side," he said. "Maybe the growth rate of capacity needs to slow down [for] a year or two."
Burns said Crown Cork poured too many of its resources in the 1990s into its PET business, which has been slow to recover.
"Crown's PET acquisitions, as a defensive alternative to [its] beverage can [business], was very sensible at the time, but technology has changed. They paid a little more than they should have, and competitors emerged," Burns said. "You've got a marketplace that is growing, but the growth is slowing."
Tiss feels almost the same way about Graham, except he expects Graham's recovery to be smoother and more successful than Crown Cork's.
But unless Graham can follow up the good luck it has enjoyed with Ocean Spray and Gatorade beverage-container conversions, there really isn't much opportunity left for growth.
"Once you finish converting to plastic, I've never seen a follow-up market," Tiss said. "So far, all that you've really seen is one wave of conversions.
"If that continues, this is a finite market."
