O-I's Heart Of Glass: Focus Spawns Growth
Keeping A Lid On Their Costs
BY BRAD KELLY
INVESTOR'S BUSINESS DAILY
Shoppers are well aware that many of their favorite products are getting more expensive. What they might not know is that so are the containers those products are shipped, stored and sold in.
Rising energy costs are cutting into the margins of container manufacturers and raising prices for consumers.
Last Wednesday, oil surged $5 to an inflation-adjusted record high of $104.52 a barrel, and there are no signs that a significant pullback is in the immediate future.
Container and food packaging manufacturers depend heavily on oil and natural gas to operate factories for making glass, metals, plastic containers and even paper mills.
Owens-Illinois (OI) produces more than 50 billion glass bottles at its 83 factories worldwide, for example, spending roughly $1 billion annually on energy alone.
From the production line to transportation, energy costs are affecting the container and packaging industry on multiple fronts, says Christopher Manuel, an analyst at KeyBanc Capital.
"Productivity and cost savings are a way of life for a manufacturing company," Manuel said.
Still, the cost of doing business in the container industry creates a high barrier to entry, resulting in a relatively exclusive club. That has helped shield the industry, which as of Friday ranked No. 31 among IBD's 197 industry groups, up from No. 119 six months ago.
Each piece of the container and food-packaging industry is different, since the definition of a container can range from consumer products found on store shelves to large industrial drums and pallets, called rigid packaging.
Consumers are more familiar with products such as glass beer bottles, soda cans, plastic water bottles, storage baggies, trash bags, paper plates, cups and pizza boxes.
Depending on the type of package, manufacturers use raw materials such as plastic resins, glass, aluminum, tin-plate steel and paper pulp.
Ghansham Panjabi, an analyst at Wachovia Capital Markets, says that the industry has mostly consolidated into a few big players. But the plastics segment remains fragmented and might be ripe for acquisitions.
In glass, O-I is by far the biggest, garnering about 45% of the North American market. French conglomerate Saint-Gobain and Anchor Glass Container are the other two big players.
Ball (BLL) controls about 36% of the beverage-can market in the U.S., including its joint venture with Coors Brewing, a unit of Molson Coors Brewing Company. (TAP)
British packager Rexam and a division of Anheuser-Busch (BUD) both have about a 22% share of the beverage container segment.
In plastics, many players compete, Manuel says. About a dozen players make polyethylene bottles for water or soda. Even the biggest have 20% or less of the market.
"It's unconsolidated because there are low barriers to entry into plastics, unlike glass," Manuel said.
Pactiv (PTV) competes in plastics but focuses on food-service packaging — 60% of its sales — and its Hefty line of garbage bags and food containers.
Some companies in the group, such as Crown Holdings (CCK) and Silgan Holdings, (SLGN) operate in a few different segments within the industry.
Name of the Game: Keep costs low through strategies such as buying in bulk, using efficient factory equipment and building factories near the customer base to lower transportation costs.
The packaging industry represents a $500 billion market worldwide. The U.S. accounts for about a third of that, Manuel says.
Worldwide, plastic- and paper-based packaging constitutes about 35% of the market; metals account for 20%, and the rest is made up of glass.
The industry sells directly to big retailers and mass merchandisers, such as Wal-Mart (WMT) and Costco Wholesale. (COST) Packagers also sell to large supermarket chains, drugstores and convenience stores.
Pactiv also targets large food service distributors such as Sysco (SYY) and U.S. Foodservice, and supermarket distributors like Bunzl.
Packagers such as O-I and Pactiv have built an extensive network of factories located near customers.
For example, Pactiv has nearly 40 factories around the world, but the majority of those are in the U.S., says CEO Richard Wambold.
"Almost all of the products we make go into multiple channels, which gives us scale, critical mass and allows us to have low-cost manufacturing," he said. "That means we can make most of the products in the region in which they're sold."
Rising raw materials costs are a major challenge facing most packagers, says John Burke, president of the Food Service and Packaging Institute.
The price of commodity resins such as polyethylene, polypropylene, polystyrene and polyethylene terephthalate jumped 3% in the fourth quarter of 2007 from the previous quarter, according to Wachovia Capital Markets.
Plastic resins may see even bigger hikes; they're made from oil, natural gas or both, adding even more to costs for manufacturers.
Manufacturers can combat higher prices a few ways. The most common is to pass costs on to the customer. Others companies, such as Pactiv, are big enough to buy materials in bulk.
"Buying counts in this industry," Wambold said. "We buy in very, very large quantities, which allows us to obtain raw materials at a lower cost than our smaller competitors."
The containers industry is a mature one, with slow to flat growth. The biggest growth opportunities lie overseas in emerging economies, Manuel says.
Rapid growth in developing nations is raising the buying power of the working class. Consumers can spend more money on food and beverages, one of the container industry's biggest customer segments.
Dave Hoover, president and CEO of Ball, sees big potential for beverage-can markets outside the U.S., particularly in central and eastern Europe and the BRIC countries of Brazil, Russia, India and China.
"Ball is expanding operations in several of those areas to continue to supply customers as they grow," said Hoover.
The U.S. market is a cash cow for this industry; the real growth exists in emerging markets. That bodes well for companies with a diverse global footprint, Manuel says.
Curbing energy costs remains a top priority for the industry.
That's especially true for glass manufacturing, a process that requires furnaces to reach temperatures of 1,800 degrees Fahrenheit to melt glass, says Joe Cattaneo, president of the Glass Packaging Institute.
O-I is working to conserve energy with improved furnace designs that can melt glass more efficiently. Most manufacturers of plastic, metal and paper have similar energy-saving techniques.
Another money-saving approach is cutting the amount of material used in a container, a process called lightweighting. Glass and plastic manufacturers can shave weight off a container without reducing the capacity.
"Reducing weight out of a container cuts energy (and) raw material consumption and lowers transportation costs, all while reducing the waste stream," Cattaneo said.
Another industry buzzword is "sustainability."
Makers of glass containers are probably the best example of using recycled products, known as cullet. Recycling extends the life of a furnace and reduces energy costs. As a rule of thumb, energy costs drop 0.5% for every 1% of cullet used, Cattaneo says.
Paul Butts, O-I's director of investor relations, says that Europe is better at recycling than the U.S. In Europe, O-I uses as much as 80% recycled glass in its operations, but in the U.S. the rates are just about 25%.
Other efforts, such as using biodegradable materials, is expensive and hard to do on a big scale, Panjabi says.
"The next leg will be biodegradable packaging, but that is still 10 years off or so," he said.
Many industries are reeling from the one-two punch of the housing and credit crisis. Not container makers.
"Packaging is not quite recession-proof, but it's close enough," Panjabi said. "Their top-line profile is fairly predictable, with more than 75% of the industry selling into defensive end-markets such as food and beverages."
In 2007, when many other industries were hit hard by the U.S. economic downturn, IBD's container industry group rose 2%.
People buy more packages in an economic downturn, Hoover says. Consumers tend to turn to more value-oriented products, such as multipacks, which are standard offerings for cans and bottles.
"People still need to eat and drink even in a weak economy," Hoover said.
Panjabi sees growth opportunities in emerging economies offsetting sluggish U.S. growth. "Cheap, safe sectors do well during downturns, and the container industry is no exception," he said.
Upside: The container and packaging industry is made up of steady, stable businesses that know how to grow earnings. As developed economies such as North America and Europe deal with stagflation, packagers will look to emerging economies for growth opportunities.
Risks: Rising energy and raw materials costs continue to hurt the business on many fronts. The biggest challenge will be managing supply costs.