Description

An investment in Brodrene Hartmann A/S (“HART DC”) is an attractive investment as HART DC is a market leading egg packaging producer trading at 10.6x 2016E P/E, a 44.9% discount to peer Huhtamaki, despite averaging a respectable 20.3% ROIC over the last five years.  The egg packaging market is stable due to its oligopolistic characteristics as well as the stable demand for eggs given they’re a cheap form of high quality protein.  Due to their low cost, eggs also tend to be resilient during recessionary periods.  Catalysts to value creation are increasing profitability driven by management’s restructuring and capacity expansion programs that will drive >20% earnings growth next year.  This opportunity exists because HART DC is a small capitalization company with $279mm of market value, no analyst coverage, and limited float of $88mm.  Therefore, this might be a PA trade for many on VIC.

Background:

Founded in 1917, HART DC is Europe’s oldest producer of molded fiber egg packaging with a 40% market share.  HART DC is also a leading producer of machinery and technology to egg packaging manufacturers outside of the markets in which HART DC competes.  Barriers to entry in the egg packaging industry derive from technological know-how, long-term customer relationships, a long history and reputation for quality packaging as the producer is dealing with food products, as well as customer demands for localized commodity scale production.  For these reasons, smaller players have historically been shut out of HART DC’s markets.

As background, molded fiber egg packaging is made from 100% recycled paper, which is an ideal packaging material due to its strength, versatility, and its significant environmental benefits.  As a result, molded fiber has long been the dominant form of egg packaging in Europe and is increasingly becoming popular in America.  A study done in the UK highlights the reasons why molded fiber is preferred by both consumers and packers over foam and plastic packaging:

Business Overview:

HART DC manufactures a broad portfolio of customizable egg packaging for over 1,500 customers across several countries.  HART DC’s technical expertise and ability to customize has driven demand for premium packaging to over 40% of HART DC’s sales today.  Premium packaging continues to grow as customers seek ways to differentiate themselves at retail.  HART DC’s European business is ~60% of sales and, within Europe, HART DC manufactures approximately 9,000 different labels with packaging of various sizes and colors.  HART DC’s scale is impossible for smaller players to replicate and a reason why HART DC’s market share in Europe has been steady for years.  HART DC is also well diversified globally with nine plants (four in Europe, one in Canada, and four in South America) with no major customer concentration in any of its markets.  HART DC has >30% market share of molded fiber egg packaging in all areas it operates.

HART DC is in the final innings of an operational turnaround that has significantly improved its profitability.  HART DC’s legacy management team was both poor managers and capital allocators.  Following the 2010 death of HART DC’s Chairman, a new Chairman took over and together with a new CEO, they completely overhauled top management starting with the CFO and COO.  New management simplified the business and improved the cost structure by moving away from non-core and loss making activities.  While management’s cost restructuring has been successful by more than doubling EBIT margins, there is still considerable room for improvement as management is now focused on optimizing manufacturing facilities and improving HART DC’s sales mix with its premium offerings.  By 2017, HART DC will have ~13% EBIT margins (management’s ‘17E EBIT margin guidance is 12-14%), finally in-line with peer levels. 

Growth Drivers:

The egg packaging industry grows 2-3% each year in-line with increases in egg consumption.  HART DC has achieved slightly higher growth rates driven by increased demand for premium packaging and a shift to molded fiber away from plastic in North America.  The shift to premium packaging has been an important growth driver for HART DC customers as eggs are one of the most profitable items on grocer’s shelves.  A retailer can generally charge $2 more per carton of premium eggs (from $2 to $4) while paying 10-20c more per carton for premium packaging.  The increased penetration of molded fiber in the U.S. has been driven by customer demand for sustainable packaging alternatives and growth in chains like Whole Foods – it’s hard to sell organic eggs in plastic/foam packaging.  Molded fiber is only 50% of the market in America versus over 80% on average in Europe with some European markets like Northern Europe at 100% penetration.  In areas like South America, egg consumption is on the rise with increased urbanization helping drive continued demand for HART DC’s packaging.  With fully utilized plants, HART DC will expand capacity in North and South America by more than 10% in the 2H of 2016 to fulfill continued demand.  This follows a 33% increase in North American capacity over the past two years that remains fully utilized.  The increased capacity plus further plant optimization activities will drive HART DC’s significant earnings growth next year.

Risks:

The key to an investment in HART DC doing well is that current earnings are sustainable or can increase in the future.  Therefore, a risk is that input costs increase and cause margins to decline.  HART DC’s largest input cost is recycled paper and pricing for recycled paper continues to remain steady.  HART DC’s second largest cost is energy (electricity and gas) and the company signs fixed price agreements for 6-12 months for its energy usage.  Additionally, HART DC has reduced its energy usage by over 20% during the turnaround process, so HART DC will likely continue to lower its energy bill.  Therefore, input costs are likely to be at least neutral to HART DC and margins are sustainable.

Catalyst

With margins still below normalized molded fiber egg packaging levels and a clear path to >20% earnings growth by year-end 2017, HART DC is significantly undervalued at 10.6x this year’s earnings.