Verallia: Europe's Largest Glass Container Producer Available At A 10% FCF Yield (OTCMKTS:VRLAF)

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Verallia (OTCPK:VRLAF) is a French company and a major producer of glass bottles with production in South America and Europe. The company produces approximately 17 billion bottles and jars in its 63 furnaces in 12 countries. The largest portion of the produced bottles are used for wine and sparkling wine while an additional 26% is used for beer and spirits. Verallia is the world's third largest producer of glass bottles and jars and is the number 1 in Europe, which accounts for in excess of 85% of its revenue.

Verallia Investor Relations

Verallia's primary listing is on Euronext Paris where it is trading with VRLA as its ticker symbol. There are currently approximately 117M shares outstanding (after deducting the treasury shares) for a total market capitalization of 4.5B EUR. The average daily volume in France is just over 140,000 shares, making it the most liquid listing of Verallia.

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Verallia posted an excellent result in 2022. Its plants were running at full capacity to keep up with demand and thanks to a smart energy hedging policy it was able to keep the impact of the higher natural gas prices throughout the year pretty limited. This, in combination with a strong demand for glass containers (this wasn't Verallia-specific as for instance O-I Glass (OI) also reported very strong demand for its products) allowed Verallia to exceed expectations.

The total revenue increased by in excess of 20% to 3.35B EUR while the COGS increased by just around 25% despite the pressure on the cost of raw materials. Although the COGS increased at a faster pace than the revenue, the small increase in the SG&A expenses helped to boost the operating profit by approximately 40% to in excess of 550M EUR.

Verallia Investor Relations

The net finance expenses also increased but this didn't have a major impact: the pre-tax income came in at 478M EUR resulting in a net income of 355.6M EUR of which 13.6M EUR was attributable to non-controlling interests. This means the net income attributable to the common shareholders of Verallia was 342M EUR which works out to 2.92 EUR per share. That's an increase of in excess of 40% compared to FY 2021.

One of the main reasons why I initiated a long position in Verallia in 2022 is the company's excellent ability to convert its net income and EBITDA into free cash flow. This wasn't any different in 2022.

The reported operating cash flow was 699M EUR but this includes about 93.5M EUR in working capital contributions while we should also deduct an additional 17M EUR in taxes based on the total taxes owed rather than the amount of taxes paid. We should also deduct the 28M EUR in interest expenses to end up with an adjusted operating cash flow of 590M EUR.

Verallia Investor Relations

The total capex was 367M EUR, resulting in a pro forma free cash flow result of 223M EUR and about 210M EUR if we would deduct the net income attributable to the non-controlling interests. Keep in mind Verallia has been investing in growth as it tries to increase its production capacity at a low single digit percentage per year. The corporate presentation (below) confirms the sustaining capex is much lower than 367M EUR. Only 270M EUR was classified as sustaining (recurring) capex. That's higher than anticipated but that's entirely caused by the recent inflation. Verallia budgets about 8% of its annual revenue for sustaining capex, so 270M EUR is not surprising.

Verallia Investor Relations

It does mean the underlying sustaining free cash flow came in at 307M EUR or 2.6 EUR per share, and that obviously is a good result. It allowed Verallia to hike its dividend by 33% as the company is proposing to pay a dividend of 1.40 EUR per share.

The cash flow statement also shows Verallia spent almost 250M EUR on an acquisition. This is related to the acquisition of Allied Glass, a UK based producer of glass bottles in the premium segment. The company has an annual revenue of 150M GBP but nor the EBITDA nor the net income were disclosed. But assuming the company has a 20-25% EBITDA margin (Verallia's own EBITDA margin exceeds 25%), it looks like Verallia acquired Allied at about 8 times EBITDA which isn't expensive at all.

The EBITDA contribution from Allied Glass also helped to boost the full-year 2023 guidance as Verallia is now guiding for a full-year EBITDA of 1B EUR.

Verallia Investor Relations

Assuming the depreciation and amortization expenses increase to 325M EUR (295M EUR in FY 2022) and assuming the interest expenses increase from 28M EUR to 35M EUR, a 1B EUR EBITDA implies a pre-tax profit of 640M EUR, and a net income of in excess of 400M EUR. The free cash flow result should be slightly higher than that, and will likely exceed 3.50 EUR per share.

Verallia is lucky to have locked in the interest rate on about 1B EUR of its debt. Additionally, the floating rate debt was hedged and about 92% of the total debt is either fixed or hedged. This means Verallia will be shielded from the recent interest rate increases although we will see an impact from Q4 2024 on when the 500M EUR loan will have to be refinanced. But by that time, the free cash flow machine will be nicely humming again and thanks to Verallia's pricing power, I’m not really expecting a massive impact from increasing interest rates until 2028. And even if you would assume the 2028 loan will see a 300 basis point increase in the cost of debt, the after tax free cash flow per share would be impacted by just 10 cents per share.

Verallia Investor Relations

In the ESCI portfolio, a long position was established in 2022 at an average price of 22.31 EUR with the most recent purchase being a top-up at 22.76 EUR per share in June. Ever since adding Verallia to the portfolio, I was aiming for an exit point around 40 EUR per share. As the situation got a bit trickier and as the natural gas prices remained at elevated levels until pretty recently, I didn't want to expect too much from a heavy user of natural gas and I wrote a call option against the position which would result in an average exit price of just under 35 EUR per share for a capital gain of in excess of 50% and a total return of close to 60% in about a year time.

Seeing how strong the fourth quarter was, and seeing the FY 2023 guidance, it looks like I pulled the trigger too early. While I’m definitely happy with a 60% return in about a year, I am (pleasantly) surprised by Verallia's guidance while the decreasing natural gas price in Europe will obviously also play a big role in protecting Verallia's margins.

I will keep an eye on Verallia and perhaps I will re-enter the stock on any weakness. As based on the prospects for 2023, Verallia is still cheap. If I would have known what I now know, I would not have sold Verallia.

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Analyst's Disclosure: I/we have a beneficial long position in the shares of VRLAF either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I still have a long position in Verallia but I have written call options against the position. Those calls are now in the money and the shares will likely be assigned soon.

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