Description

Richards Packaging Income Fund (RPI.UN-T)

When looking at names suffering from a COVID related hangover, one would not typically think of Richards Packaging Income Fund (RPI) - a full-service distributor of packaging products and healthcare supplies. As a leading North American distributor with a history of accretive acquisitions, minimal equity issuance and compounding earnings double digits since IPO, RPI at 7x 2023 FCF is too cheap for a good business that can continue to grow over the long-term.

Investment thesis summary: 

1. RPI is a good business serving as a distributor of packaging products and healthcare supplies, especially for small to medium sized businesses (SMEs) that cannot easily access product directly from the large packaging companies (Berry, Silgan, etc.).

2. Having been around for over 100 years, RPI has established significant market share and relationships with SMEs and packaging companies. The nature of the business is also not very capital intensive, leading to high FCF conversion.

3. Management and board are aligned, holding almost 30% of RPI and have been very disciplined with acquisitions – helping compound earnings at double digits since its 2004 IPO.

4. COVID gave RPI a one-time boost to sales and earnings given the elevated demand for items such as plastic containers and pumps for hand sanitizers. Despite RPI communicating the magnitude of this non-recurring impact, the market proceeded to value RPI at almost C$1 bln market cap at its 2020 peak. Now RPI is valued at ~C$350 mln. 

5. We suspect RPI’s limited float and quirky tax situation preventing buybacks likely exacerbates current mispricing. 

6. With likely normal GDP+ type growth, RPI is probably a double here, especially as continues to pay down acquisition related debt on its balance sheet. We are getting a free option for further accretive acquisitions, which historically created value (3x+ upside). Given a non-capital intensive business, there isn’t much hard asset downside protection. However, based on capital raised/deployed with RPI’s IPO and acquisitions, we guesstimate a downside here at > $20 per unit.

Background

Although RPI has been around for over 100 years, it became public in 2004 as an income trust, raising $68.8 mln. Similar to REITs or MLPs, income trusts in Canada had favourable tax attributes when income is distributed to unit holders (although this structure/loophole was subsequently shutdown by the Canadian government). 

Initially accounting for ~4% of the North American distributor market (based on RPI’s disclosures), RPI grew its cosmetics and healthcare end markets at double digit rates for almost the next 20 years (food & beverage grew at market rates ~ 4%). RPI’s success likely came from building strong relationships with SMEs, making disciplined acquisitions, and increasing RPI’s market share in the space, while the distributor market continued to consolidate (i.e. pricing power). With limited capex requirements, RPI pays a monthly distribution, augmented by a special distribution especially when they are not active with M&A. 

Industry Observations

We don’t have any earth breaking insight into the packaging space but can make two general observations that help make the case for RPI:

1. North American Packaging Consumption can probably grow at GDP+ on average:

2. The distributor market (according to RPI) became more concentrated over time, with the top 5 players now accounting for ~60% of the market, whereas it was in the 36% range when RPI first became public:

The above observations serve as a basis for our expectations for GDP+ top line growth over time and for RPI’s margin’s to remain sustainable given the industry concentration.

Capital Allocation Skills

As with many owner operated businesses, RPI historically has been very reluctant to issue equity to fund acquisitions. Since IPO, RPI had 10.7 mln diluted units and in 2022, the diluted unit count only grew to 11.4 mln (+0.4% CAGR). 

When RPI makes acquisitions, they tend to be smaller in size and RPI pays generally very reasonable valuation multiples. 

While it is hard to separate M&A and organic growth over very long periods of time, we can see RPI’s revenues grew an 8% CAGR from 2004-2022 and RPI’s diluted income per unit did a 12% CAGR over the same period. In others words spending ~$125 mln in acquisitions helped RPI grow revenues from $113 mln to $447 mln (2004-2022) and adj. EBITDA from $14.5 mln to $64.4 mln. Not being a capital intensive business, RPI also returned ~$230 mln in distributions to unitholders over this time frame.

Market Valuation – Upward Trajectory Until COVID Hangover

As RPI built its track record of unitholder friendly growth and return profile, RPI (according to Bloomberg anyway) initially traded at ~10x P/E in the early 2000’s before its multiple expanded to closer to 30x, coming out of increased demand for packaging products associated with COVID-19.

For reasons beyond my comprehension, the market gave RPI a “high” multiple on earnings during COVID-19. This is despite RPI specifically singling out the impact of Coronavirus in its numbers in its 2020 MD&A. 

Not surprisingly, as the Coronavirus impact reversed, RPI’s revenues almost exactly decreased by the one time impact management disclosed – from $489 mln revenues in 2020 to $426 mln revenues in 2023. 

While there are legitimate headwinds associated with weaker SME demand (especially in the food and beverage space), it is equally interesting that RPI now trades at ~11x P/E according to Bloomberg (and 7x FCF based on 2023 numbers)

Fundamental Valuation

Base Case - Given the significant revenue declines, especially in the food & beverage category, we assume revenue growth resumes at ~3% range in 2025. Without any other meaningful boosts to the business, we think RPI’s value is in the $60 per unit range, almost a 2x from here. With the FCF generation, RPI is likely on its way to be debt free and consider higher year end special distributions.

Upside Case – We assume RPI can replicate its historical skillful M&A, deploying another ~$200 mln in accretive acquisitions over the next 5+ years. On that basis, we get a fair value in the $80 per unit range, almost a 3x from here (and compounding over time).

Downside Case – Due to all the distributions paid over the years, we think book value might be a bit distorted. Instead, we looked at all the capital RPI put to work over the years + IPO proceeds and assume some working capital value. We get a downside case in the low $20s per unit range.

Why Does This Opportunity Exist?

I think this opportunity exists because:

1. Decline in revenues due to COVID hangover. Combined with a limited float and liquidity, unit price and valuation appeared to gyrate wildly, especially in the past few years. 

2. RPI cannot buy back units. Due to its income trust structure, RPI has been providing some distributions in the form of return of capital historically. Therefore, the paid up capital of RPI units are close to zero and any unit buyback creates a punitive tax result. 

3. RPI historically (and still) does not need access to the equity capital markets. As a result, RPI has one analyst covering the name and does not host conference calls. We understand RPI had Acumen partners market the company and it appears investors misunderstand this to mean an equity issue might be coming.

Disclaimers: Not investment advice, write-up subject to errors, do your own due diligence. No obligation to update changes in our holdings.

Catalyst

FCF, Distributions, Acquistions