Rubber and Plastics: 2 to Love, 2 to Shun

You probably don't know these names, but two have plenty of appeal

   

I’ve said it before, and I’ll say it again: Most of my very best stock picks have come from industries most investors didn’t even know existed, and were companies most investors had never even heard of.

My latest search for the obscure has led me to a group of equities that — despite a recent rally — is well undervalued. That industry? Rubber and plastics.

The name that immediately comes to mind regarding this category is Goodyear Tire & Rubber (NYSE:GT), and that’s largely because it’s the only name in the category most investors have even heard of. When you dig deeper into the admittedly boring world of plastics, however, a couple of the mid-tier companies really stand out as solid investment candidates. On the other hand, a couple of others stand out as names to steer clear of.

Two You Want

When an investor first learns that $2.1 billion company Berry Plastics (NYSE:BERY) — an organization that racked up $4.7 billion in sales and turned in $726 million in EBITDA over the past four quarters — is also sitting on $3.9 billion in debt, eyebrows might be raised. Indeed, even recent efforts to refinance just $1 billion in debt that’s maturing between now and 2016 doesn’t immediately feel like it’s a step in the right direction. The terms of the new term loan call for an interest rate that’s 3% more than the LIBOR rate.

What investors may not recognize is that such leverage is actually pretty common in the packaging industry, and that Berry Plastics can produce a top and bottom line that’s consistent enough to handle a seemingly high debt load.

Margins are paper thin, but for a highly levered company like Berry Plastics, that may actually be a good thing. If the refi makes the company’s debt any cheaper at all, it can magnify the positive impact on the bottom line. Translation: Berry may be much more profitable in 2013 than it’s currently getting credit for.

If you’re looking for hardcore organic growth rather than accounting-statement growth, then consider AEP Industries (NASDAQ:AEPI). In 2012, AEP’s bottom line was up 87%. Most of it stemmed from just plain-old increased demand and good expense control. It’s unlikely AEP can maintain that pace, but it doesn’t need to — it already has the market’s attention.

Two You Don’t Want

When it rains it pours, at least for Rogers (NYSE:ROG).

Truth be told, through early January, things were going fine for the Connecticut-based foam supplier. The stock was still beaming from the earnings beat in November, and Zacks deemed it a buy in late December, largely based on earnings growth. The analytics firm projected a long-term earnings growth rate of more than 13%.

As it turns out DA Davidson may have had its finger on Rogers’ pulse more so than Zacks did. Davidson downgraded Rogers from a buy to neutral in mid-January, and just a couple of weeks later Rogers reeled in its fourth-quarter sales outlook by about 6%. It’s Q4 EPS guidance is now about half of what it was just a few weeks ago.

One stumble does not a disaster make. But, if clichés apply, here’s another one: Where there’s smoke, there’s fire. All too often, one round of lowered guidance can become two, and three…

If for no other reason than the acquisition process of Spartech (NYSE:SEH) is already under way (and the stock has already reached close to its maximum value), it’s best avoided. Even if the PolyOne’s purchase falls through though, Spartech is still a mess.

Not that any plastic or rubber company is generating profoundly high margins, but Spartech has been putting up plastic-wrap-thin margins for a long, long time. Over the past four quarters, Spartech’s net profit margins have been just a tad over 0.2% … and that was a fairly typical year. It works, but it leaves no room for error. The market doesn’t like no room for error.

If that weren’t alarming enough, Spartech’s CEO is now due a $5 million golden parachute if the PolyOne buyout happens — an arrangement that was made after the offer was on the table.

Just for perspective, Spartech has lost a total $60 million over the past four years, and the CEO is going to put $5 million in her pocket for being lucky enough to find a buyer for the struggling company. Granted, the acquisition is the best thing that could happen for shareholders, but on the off chance PolyOne backs out, Spartech doesn’t have much else going for it, and we’ve already seen a glimpse of management’s character.

As of this writing, James Brumley didn’t hold a position in any of the aforementioned companies.


Article printed from InvestorPlace Media, http://investorplace.com/2013/02/rubber-and-plastics-2-to-love-2-to-shun/.

©2014 InvestorPlace Media, LLC

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