If the Crown Fits, Wear It

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SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

September 2nd, 2015

If the Crown Fits, Wear It

  • We believe the consolidation, regional nature, and capital intensity of the global beverage/food can industry offer the major global players a scale advantage that will insulate them from the threat of Chinese exports
  • Previously we noted that BLL & CCK were priced going into 2015 as if N. America would stay strong and Europe weak
    • There also might have been some knowledge of BLL’s Rexam deal embedded there
  • N. America clearly hasn’t been as strong as everyone expected, rail volumes have indicated lackluster demand, and consumer non-durables remain weak
    • Crown has outperformed Ball by 6% since January, and the pairs trade is an 8% outperformer vs. the market on the year
  • Ball may be distracted by the acquisition process
    • The Rexam deal is currently facing scrutiny from the European commission
    • This is an industry where even small operational hiccups can loom large – plants need to be running efficiently and at high operating rates
  • Crown meanwhile has already successfully integrated two recent $1B acquisitions and so has grown through continued malaise in Europe and instability in the Middle East
    • Presence in emerging and frontier markets (SE Asia, Middle East, Mexico) makes Crown a long term growth story despite instances of short term volatility
    • Recent acquisitions have improved its can mix in N. America (now 40% beer, 60% carbonated soft drinks) and margins
  • The valuation gap between the two stocks remains at or near historical extremes
    • CCK screens favorably versus BLL on our normalized earnings models (Exhibit 1), on an EV/EBITDA basis, P/E relative to the S&P, and FCF yield (Exhibit 2)
  • Crown’s 2016 estimates have held in better than Ball’s despite greater currency exposure

Exhibit 1

Source: Capital IQ, SSR Analysis

Overview

We continue to explore the theme of ascendant Chinese exports and search for companies and industries that have a measure of insulation from this competitive pressure. The global can makers have a considerable scale advantage versus Chinese competitors. Within China itself the market remains highly fragmented and oversupplied, but in more rational markets this is a cost based business with significant economies of scale.

As such, the global beverage/food can industry is highly concentrated. Ball’s acquisition of British peer Rexam will create an effective duopoly – the combination of BLL/Rexam and CCK will control over 80% of North American capacity, 90% of European capacity, and virtually all of Brazilian capacity. This is also a very regional and capital intensive industry – can plants are often located adjacent to bottling facilities, and require significant capital investment.

On the basis of our China thematic, we would be favorable on both CCK and the BLL/Rexam entity for geographical scale, existing presence in regional markets, and ability to make capital investments. Between the two, we prefer CCK on the potential for multiple valuation metrics to normalize in its favor relative to BLL, particularly given that Ball’s merger preoccupation could distract from day to day operations.

Historical Valuation Trends Suggest Normalization in CCK’s Favor

Forward multiples (EV/EBITDA, Relative P/E) for BLL and CCK remain at historic levels of divergence. From a free cash flow perspective, CCK looks particularly attractive – its yield is significantly higher than BLL’s and above the sector average. The past several years have seen a consistent pattern of CCK trading above BLL on a FCF yield basis, only to normalize quickly. Despite Crown’s free cash flow generation, the company does not offer a nominal dividend as Ball does (0.8% yield) – at some point we would expect this to change which could open up the stock to a new subset of investors who may be ignoring the name due to its lack of yield.

Exhibit 2

Source: Capital IQ, SSR Analysis

CCK Estimates Have Held in Better Despite Greater Currency Exposure

Crown sets up as a superior long term investment due to its presence in emerging and frontier markets, but this growth aspect comes with significant currency exposure (CCK is 74% international, while BLL is 60% US for comparison). Despite this, estimates have held in considerably better for Crown over the past year as the dollar has strengthened.

Exhibit 3

Source: Capital IQ, SSR Analysis

Business Momentum Appears to be Favoring Crown

Looking at Q2 margins, CCK appears to be enjoying more positive momentum than BLL – Exhibit 4. In beverage cans Crown’s margin accelerated much more than Ball’s did, and in food cans Crown saw substantial improvements driven by the Mivisa acquisition while Ball was unable to overcome the loss a major food can customer (Conagra).

Exhibit 4

Source: Capital IQ, SSR Analysis

There is still not much in the fundamentals that would indicate BLL should trade at such a premium to CCK – Exhibit 5.

Exhibit 5

Source: Capital IQ, SSR Analysis

©2015, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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