The recent collapse of investment bank Bear Stearns Cos. Inc. and its buyout by JPMorgan Chase & Co. caused turmoil on Wall Street. It has been the starkest reminder of the credit crunch that is affecting the plastics and packaging industries, along with nearly everyone else in the U.S. economy.
But at the Packaging Strategies Summit Meeting, held March 12-14 in Fort Lauderdale, a representative of one of the top U.S. financial services companies said there are ways for packagers - especially those active in mergers and acquisitions - to navigate the storm.
``Companies that have an appropriate level of debt leverage clearly have a greater capacity to withstand operating challenges, missteps or pressure in difficult economic times,'' said Liley Mehta, director of Standard & Poor's corporate and government ratings. ``Maintaining an appropriate financial policy also provides flexibility to pursue attractive opportunities as they arise.''
Mehta highlighted several recent overall packaging industry trends, including:
* A wave of leveraged buyouts with steadily increasing corporate debt levels.
* An increase in the number of companies receiving S&P's ``B'' rating - which indicates a company's financial situation varies noticeably - on S&P's AAA to D ratings scale.
* Record mergers and acquisitions activity.
* High private equity group activity.
According to S&P's, plastics companies such as Bemis Manufacturing Co. (A rating) and Pactiv Corp., Sealed Air Corp. and Sonoco Products Co. (all three rated BBB, the lowest investment grade) are better credit risks than Ball Corp., Owens-Illinois Inc., Plastipak Packaging Inc. and Silgan Holdings Inc. (BB rated); AEP Industries Inc., Berry Plastics Corp., Consolidated Container Corp. and Graham Packaging Co. (all B's); or Portola Packaging Inc. and Solo Cup Co. (CCC), because they have better operating cash-to-debt ratios, Mehta said.
She said debt reduction will be top priority for most packaging companies and liquidity their biggest stumbling block. She said most ``B'' profiles have narrow product lines, heavy customer concentration and are vulnerable to raw material price fluctuations.
Another concern for S&P is its prediction that U.S. corporate default rates could peak at their highest point since 2001.
While resin costs are expected to fall in 2009 and beyond, she said, once Middle Eastern resin production ramps up, processors face a pricey 2008, with implications that depend on whether they make rigid or flexible packaging.
``In rigid-packaging companies, most of those benefit from multiyear contracts with customers that allow them to pass through raw materials prices [to customers] with a time lag,'' she said. ``In past years, that used to be a quarter or a couple of months. Recently, given the volatility of resin prices, we've seen that time line shrink to a month or even less as they try to pass that through more quickly.''
On the flexible packaging side, with fewer long-term processor-supplier relationships, there's even less ability to pass through raw materials prices to customers, Mehta said. ``We've seen margins squeezed and companies try to focus on cost reduction to offset those margin pressures.''
A slowdown in consumer spending isn't helping, as demand for food and beverage packaging has dropped. There's also the downsizing of packaging as retailers like Wal-Mart Stores Inc. seek reductions - most noticeably in the move to double-concentrated laundry detergent.
``Still, overall, considerable consolidation opportunities remain, in the fragmented rigid and flexible plastic segments,'' Mehta said. ``We expect to see considerable M&A activity as larger players play a consolidator role.''
Some of the best news for packaging, Mehta said, is that few companies have looming debt maturities in 2008-09; most of the notes won't be called in until 2011-12.
``So that positions companies quite well - gives them room to actually focus on earnings growth and building cash flows until those debt maturities come out.''
This year, private equity will play a diminished role in packaging M&As, making room for strategic players to exercise more muscle, Mehta said. Debt-leveraged buyouts will decline, as banks tighten their lending rules.
``Clearly, financial profiles need to improve,'' she said. ``About half the companies that we rate have financial profiles that are sub-par for their ratings and they need to focus on improving earnings, improving cash generation, pay down debt and improve credit measures to appropriate levels.''
For strong business profiles, firms should set their sights on value-added packaging, innovation and design capabilities, she said. Customer, geographic and end-market diversity are key and global players will benefit from growth in emerging markets in Asia and Eastern Europe, she said.