In the current economic landscape, both economic growth and inflation seem to be under control. However, concerns about a potential recession linger, and the Fed’s aggressive interest rate hikes aggravate these concerns. In today’s FA Alpha Daily, we dive into Berry’s defensive qualities using the Embedded Expectations Analysis (EEA) framework to uncover the company’s true performance and see what the market might be missing.
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The markets have become more optimistic about the economy and inflation in recent months.
However, there is still significant uncertainty around the risks of recession. While the Fed is focused on curbing high inflation, a “soft landing” may be difficult to achieve.
With the labor market staying robust, the Fed seems committed to doing whatever is necessary to prevent another round of high inflation through the end of the year.
This raises the risk of an economic slowdown being more severe than expected. As a result, it makes sense for investors to consider hedging their portfolios against potential recession impacts.
One approach is to invest in defensive stocks from industries that tend to hold up well even in a downturn.
Berry Global Group (BERY) is an example of such a defensive stock.
It manufactures and supplies non-woven, plastic, and paper products for various end markets including healthcare, hygiene, and food packaging.
Notably, Berry generates most of its sales from healthcare and hygiene applications. This includes producing materials and packaging solutions for the pharmaceutical industry.
Demand for drugs and medical supplies tends to remain stable regardless of the economic cycle.
As one of the largest global packaging producers for medicines, Berry can count on continued needs from pharmaceutical companies.
While the pharmaceutical industry is a competitive one, Berry stands to benefit from total demand irrespective of which companies emerge as front-runners.
The need for reliable, high-quality packaging in the pharmaceutical sector is a constant, making Berry’s business model inherently resilient to economic fluctuations.
We can see these factors already in effect…
While the company struggled in 2019 and 2020, the Uniform ROA recovered fast from 9% and stayed around 14% in the last three years.
While Berry has shown over the years how stable its business is, the market seems pessimistic for its future.
We can see what the market thinks through our Embedded Expectations Analysis (“EEA”) framework.
The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.
In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.
At the current stock price, the market expects the company’s ROA to fall to 8%.
The market’s pessimistic view is caused by Berry’s limited exposure to consumer discretionary end markets like food and beverage.
Overall, while not immune to macro pressures, Berry’s defensive qualities make it one way for investors to gain recession protection through quality operations serving necessity-based end markets like pharmaceuticals.
Its stable business model could help offset volatility elsewhere in portfolios during periods of economic uncertainty.
SUMMARY and Berry Global Group Tearsheet
As the Uniform Accounting tearsheet for Berry Global Group (BERY:USA) highlights, the Uniform P/E trades at 16.2x, which is below its global corporate average of 18.4x but around its historical P/E of 14.9x.
Low P/Es require low EPS growth to sustain them. In the case of Berry Global, the company has recently shown a 1% shrinkage in Uniform EPS.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Berry Global’s Wall Street analyst-driven forecast is a 17% EPS shrinkage in 2023 and a 13% EPS growth in 2024.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Berry Global’s $66.43 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to grow 8% annually over the next three years. What Wall Street analysts expect for Berry Global’s earnings growth is below what the current stock market valuation requires in 2023 but above its 2024 requirement.
Furthermore, the company’s earning power is 2x its long-run corporate average. Moreover, cash flows and cash on hand are below its total obligations—including debt maturities, capex maintenance, and dividends. Also, the company’s intrinsic credit risk is 200bps above the risk-free rate.
All in all, this signals high dividend risk.
Lastly, Berry Global’s Uniform earnings growth is in line with its peer averages and its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
The Uniform Accounting insights in today’s issue are the same ones that power some of our best stock picks and macro research, which can be found in our FA Alpha Daily newsletters.