Mayr-Melnhof Karton AG
Another boring, but inexpensive, industrial with temporary issues
Founded in 1950 and based in Vienna (Austria), MMK has a global presence (71 production sites in 3 continents) and a broad client base (4,300+ customers in 140+ countries), although Europe still accounts for 80% of group sales: products from European mills are sold worldwide, but due to the limited economics (transport costs and service demands), the business of individual packaging plants has mainly a regional character.
MMK IPOed in 1994 on the Vienna Stock Exchange and is still 59% owned by the Mayr-Melnhof families, with the remaining 41% being free float.
Business operations: two independent divisions
The company operates two distinct divisions: while closely linked (MM Packaging is MM Board & Paper’s largest customer, accounting for ~15% of sales), both divisions are managed with independent profit responsibilities and supply each other at arm’s length.
MM Board & Paper (54% of group sales, 75% of operating profits): with a total annual production capacity of 2.0 million tonnes, this division is the biggest cartonboard producer in Europe. Approximately 65% of capacity is accounted for by coated recycled fibre-based cartonboard and the remaining 35% by virgin fibre-based cartonboard.
Cartonboard products are used in a wide range of applications, but mostly as packaging material in numerous consumer goods markets for daily needs; kraft papers are sold to the food/gastronomy and the laminate industries, and uncoated fine papers mainly to paper/office supply retailers.
Growth in this division is mostly achieved through sustainability and innovative products. Cartonboard and paper are the preferred packaging materials among both consumers and regulators: as such, major retailers and brand owners have committed to avoiding the use of unnecessary plastic in packaging. MMK’s aim is to create new possibilities for replacing plastic packaging with environmentally friendly solutions that can be used as an alternative packaging material for a wide range of food products including liquid, chilled, frozen and/or greasy foods. Recycled fibre-based cartonboard can be recycled over twenty-five times and degrades in two months. Management estimates that this structural shift alone accounts for circa 1% growth per annum.
MM Packaging (46% of group sales, 25% of operating profits): the core business of the other division focuses on folding cartonboard packages for consumer staples, mainly catering to multinational customers. Due to the recent acquisitions in the Pharma & Healthcare business unit (see below), MM Packaging is also quickly becoming a leading producer of leaflets and labels for these sectors.
A major part of the business is generated with large multinational customers, which account for 80% of sales (top 5 customers alone represent 35% of the division’s revenues): the allocation of demand via tender procedures and multi-year procurement agreements are the rule in international key customer business. The remaining part of sales goes to local customers: in total, MM Packaging supplies more than 2,300 customers worldwide.
As a result of significantly lower market barriers compared to the cartonboard industry, the folding carton business is characterised by a continuously, intensely competitive environment and smaller supplier structures, also requiring a much more local presence. With the recent acquisitions MM Packaging is now also presents on the US East Coast in the area of pharma packaging, while also holding leading positions in individual countries in the Middle East, South America, and the Far East.
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Markets and competitors
In recent years, the market for “paper” products got a boost from two major factors: 1) pandemic-catalysed dash for daily essentials and very high reliance on ecommerce; and 2) Europe’s resolve to maintain its green priorities, resulting in increasing adoption of sustainable packaging and growing aversion towards single-use plastics (which was also banned by EU in mid-2021). With Europe’s unwavering environmental commitments and consumer giants eventually becoming conscious of their excessive plastic usage, the euphoria for recycled packaging has hit unprecedented highs.
But while they are all generally grouped under the “Paper and Packaging” label, companies within the sector are rather a bunch of quite different enterprises with different products and different business models. For example, the US companies Crown Holdings and Ball Corp are known for their metal beverages packaging; similar considerations are valid for Tetra Laval (Sweden), which invented the Tetra Pak tetrahedron beverage packaging. On the other hand, the Nordic companies (UPM-Kymmene, Stora Enso, Holmen and SCA - Svenska Cellulosa) typically owns large tracts of forests (Sappi as well): as such, their revenues include the sale of several other wood-based products beyond paper/cartonboard (they often also have a renewable energy division – to power their plants - and produce liquid biofuels). On the contrary, MMK is a pure producer of cartonboard and similar products, buying the raw materials (both virgin and recycled fibres) mainly on the spot markets.2
The “paper industry” includes a variety of sub-sectors (tissues, office paper, …) with several degrees of overlapping, so it’s difficult to have precise estimates for MMK’s addressable market(s). In broad terms, demand drivers for packaging continue to be private consumption and general economic trends, with cartonboard recently showing for the first time the highest (predicted) growth rates.
The cartonboard packaging market is indeed growing faster than anticipated just few years ago, helped by the explosion of ecommerce and developments in digital printing technologies.
ecommerce: online retail sales are continuing to rocket, with estimates of around 20% annual growth in Europe. This will have a profound impact on packaging demand, especially in the corrugated industry as it represents 80% of demand in ecommerce. The increasingly complex logistics chain for direct-to-consumer delivery (ecommerce packages are expected to be handled up to 20 times or more during standard distribution) means there is new demand for cost-effective secondary corrugated board packaging.
Note: corrugated cartonboard production represents a different industry from that of cartonboard and folding cartons, with different products and markets in which MM Packaging does not operate. However, some of MM Board & Paper’s main products (high-quality printable and finishable top layers) are used for corrugated board products in low grammage. Therefore, despite the image to this post, MMK does NOT produce directly the nice boxes used by Amazon and other retailers!
Fit-to-product: born out of ecommerce has been the advent of fit-to-product (FtP) or box-on-demand systems, driven in particular by the needs of dedicated online sellers. This technology enables the production of customised secondary packaging based on the exact size of the product being packed, including irregular shapes. For the end-user this eliminates the need for large inventories of standard-sized boxes which often require copious amounts of filler material.
Retail changes: retail-ready packaging has established itself as a major cost saver for retailers, especially in Western Europe. This ongoing profit pressure is providing an impetus to use more retail ready formats as a labour-saving solution, as it is estimated that these secondary packaging formats can reduce shelf restocking and handling costs by up to 50%. It is also particularly popular with sales into convenience stores or discount retailers such as Aldi and Walmart. For brands it gives the added bonus of giving them greater control over the presentation of their goods within the retail space.
MMK’s acquisitions (and divestments)
Acknowledging the long-term attractiveness of the packaging market, MMK’s management has unveiled a slew of aggressive bets, focusing on growth, cost efficiency and technological innovation at both divisions.
This also includes a very active approach to managing its existing assets: in 2021 it disposed of three smaller, less efficient mills in Germany and the Netherlands to a subsidiary of funds managed by Oaktree Capital Management, while in 2022 it sold its Russian packaging sites for €134 million to a local investor.
After relatively small acquisitions in the prior years, in 2015 MMK purchased the carton operations of Ileos in France, specialised in producing folding cartons for the pharmaceutical industry and for luxury articles and cosmetics. Capitalising on its balance sheet cushion, in 2019 MMK acquired TANN Group, based in Austria and a global leader in producing tipping paper (i.e. cigarette filter paper). Then, in late-2020 and early-2021, MMK announced the acquisitions of two other assets: Kotkamills Group in Finland (specialised in innovative barrier cartonboard solutions for plastic replacement) and Kwidzyn in Poland from International Paper.
Finally (at least for the moment…), two additional purchases were concluded in 2022. First the smaller one (it added around €50 million in sales): Eson Pac in Sweden, which produces and distributes high-quality secondary packaging solutions for the pharma industry. Later in the year the bigger one: Essentra Packaging in the UK, also active in the resilient business of secondary pharma packaging. Essentra Packaging was put under review from its previous owner (Essentra plc, a manufacturer and distributor of plastic injection moulded, vinyl dip moulded and metal items) and MMK pounced at the unique opportunity to increase its presence in the segment.
The global pharma and healthcare industry is currently MMK’s top priority: driven by an aging population, innovative treatment options (for example in the fields of oncology and immunology), a trend toward home and self-medication and the increased emergence of generics, they expect a very attractive growth potential in the next years. Essentra Packaging’s footprint is highly complementary to MM Packaging’s current positioning in Europe (attractive upside potential and synergies) and will allow MMK to enter the US market with a significant position in the pharma-hub on the East Coast.
How much did they pay for this inorganic growth?
Ileos: acquired for €80 million and an EV/sales multiple of 0.7x
TANN Group: enterprise value was €350 million (of which equity was €275 million), equivalent to 1.5x EV/sales and 6.5x EV/EBITDA: at the time MMK was trading for 7.2x EV/EBITDA, and TANN had a superior EBITDA margin (23% vs 14% at MMK), so quite a good deal
Kotkamills: enterprise value of €425 million, equivalent to 1.1x EV/sales and 7.8x EV/EBITDA
Kwidzyn: enterprise value of €700 million, equivalent to 1.4x EV/sales and 7.6x EV/EBITDA
Eson Pac: enterprise value of €52 million, equivalent to 1.1x EV/sales (no other details were provided)
Essentra Packaging: enterprise value of €365 million, equivalent to 0.8x EV/sales and 9.7x EV/EBITDA
From the revenues point of view, Essentra’s acquisition seems to be a fantastic bargain, given these operations' pharma focus and US and Europe market footprint. However, it is worth noting that the acquired operations had been “neglected” by its previous corporate owner and was historically only marginally profitable (operating margins around 1%): MMK thinks they identified a huge potential to improve results, but it also has a lot of work to do in terms of achieving a major turnaround.
Financials and recent results
Despite the “deep-cyclicality” tag, the Paper & Packaging sector’s fundamentals are rather quite resilient and much less cyclical than many thinks: 2008, 2011 and 2020 were not exceptions to this rule, with ROIC and gross/operating margins remaining elevated despite macro-difficulties and recessions. The non-discretionary nature of MMK’s products is evident.
Although MMK’s European sales exposure is still extremely high, it has done exceptionally well to maintain a healthy top-line growth, averaging c.7% since 2000 and c.9% since 2009, and very stable although not spectacular ROIC and operating margins. This performance has been in sharp contrast with its paper peers, which have reeled under the pressure of dwindling paper demand, especially for newsprint, and volatile prices.
Despite the macroeconomically (price increases in energy and raw materials) and geopolitically challenging environment, sales and profit grew significantly in 2022, both for organic reasons and thanks to the recent acquisitions. Given MMK’s ability to pass on costs through higher prices, both operating and core profit margins were at their highest level ever, and net profits reached €365 million (vs a peak of €190 million in 2019): all recent acquisitions have been earnings-accretive right from the start, and their contribution helped maintain sales and profitability growth.
However, numbers were completely different in Q1 2023, with results well below the previous year’s period despite further sales growth. These results were not completely unexpected: the company had already guided at the end of last year on the difficulties it was going to face in 2023.
Despite acquisition-related (top-line) benefits, there were varying challenges in both divisions. Weaknesses were particularly felt in Board & Paper against the background of a slow destocking of high customer inventory levels as well as inflation-related restrained demand. These were in addition to planned capex-related shutdowns in two mills, which necessitated considerable downtimes. As a result of the implementation of major investments in the cartonboard mills, a further decline in volume and profits is foreseeable: accordingly, 2023 will be a transition year for Board & Paper and an integration year for Packaging. While profitability was above the trend line in 2022, it is expected to be below in 2023.
“Peter, could you explain the reason for the 45% decline in MM's operating profit for the first quarter of '23.
Yes. I mean, the decline was mainly due to weak sales volumes in our division, Board & Paper, which we had already cautioned about during the presentation of our strong '22 results. However, the historically unusual 20% volume decline in Europe in the overall market during Q1 was higher than we had anticipated. The loss of the Russian market also contributed to our volume decrease. And with regards to overseas exports, there was weak demand and strong competition.”
“In addition to destocking in the supply chain, there has been a shift in consumer behaviour due to the very high inflation of wood, which is much above the general average. And this led, on the one hand, to reduce consumption of wood, and on the other hand, also to consumers shifting towards, let's call them, budget products that typically use more plastics. Therefore, there is now a hot debate, is the trend from plastics to cartonboard still valid? And I personally think, yes, this trend will continue. However, the extent of its broad-based adoption remains to be seen. And we will only know which trends were temporary and which were sustainable in about a year or so.” (MMK’s Q1 2023 earnings call)
Add to this that the next quarters will also see further restructuring and one-offs charges: operating 71 production sites on 3 continents and acquiring a few additional unprofitable one from the former Essentra Packaging Business, there is undoubtedly room for improvement and further consolidation to enhance competitiveness. Profits in the Packaging division were already hit by a €16 million one-off charge for structural adjustments in Q1 2023.
Visibility in the industry also remain limited, as order books are defined in weeks, not months or years. As the issue at hand is not only destocking, but also the effects of reduced purchasing power and consumer spending (pass-through of increasing fixed costs is difficult during recessions), MMK believes that recovery will likely be slow and take longer.
In contrast, capex will remain elevated and will impact FCFs: guidance for the 2022-2023 period was for €250-€300 million in annual capex, but it has now been revised to >€400 million for the current year (it was €320 million last year).
MMK is indeed investing not only in modernising its machinery and state-of-the-art technologies (i.e. digital printing) in order to increase efficiency, but also in developing attractive sites close to its customers, in particular in Poland in order to participate in the market growth in Central & Eastern Europe and to take advantage of more favourable costs (and we all know what’s happening in the region at the moment).
Historically, MMK had maintained a very conservative capital structure and enjoyed a net cash position. However, the situation started changing in 2015: net debt was still maintained at a very low level (thereby retaining the possibility of more opportunistic M&As in the years to come), at least until 2019 when the bigger spending spree started. These acquisitions resulted in a debt build-up and as at Q1 2023 net debt stood at €1.5bn.
To fund this activity, in 2021 MMK issued a €1bn Schuldschein loan3: the transaction comprised tranches with fixed as well as variable interest rates with maturities from 5 to 15 years and an average duration of ~9 years. The excellent “market timing” allows MKK to have today an incredibly attractive average interest rate of 1.6% largely fixed for the next 8 years. With the business’s stability along with a good track record on effective asset utilisation, a change in the capital structure (i.e. more gearing) should not pose an existential risk, and on the other hand it increases ROE (which jumped to 20% in 2022 from 10%-13% in the previous decade). Add the effective cash generation (EBITDA for 2023 is expected to be around €600 million, down -20% from 2022 at €745 million), and net debt/EBITDA is still a manageable 2.5x.
However, EBITDA is not free cash flows (if you believe they are the same, you are in the wrong Substack…) and given the growth capex ambitions, near-term FCF restraint are inevitable concerns: cash flows were already sub-par over the last two years, mostly due to capex but also to working capital needs inherited from the acquisitions (integration of these companies is however proceeding as planned: cash flow from operating activities was up in Q1 2023, mainly from working capital optimisation). Dividends, which last year were increased by 20% to €4.20 on the back of positive business developments, could be very well cut this year to the 2018-2020 levels (€3-€3.20?).
The entire sector has been under pressure recently, with MMK however not the worst of the group: what might explain the recent scepticism?
Rate hikes/reversal of extraordinary monetary easing are taking a toll on macro-sensitive investment stories, especially the valuation euphoria (i.e., forests and timber)
Gradual post Covid-19 normalisation is resulting in waning trend of stockpiling of essentials
High inflation (especially in Europe) resulted in near-term cost pressure
Growth investments to reduce dependency on legacy paper are weighting on near-term FCFs
Using LTM numbers, MMK seems extremely cheap relative to its fundamentals:
Dividend yield: 3.1%
However, using current consensus numbers for 2023, the situation is only slightly worse:
Dividend yield: 2.2%
FCF yield: likely positive (improvements in WC), but still quite low
These multiples are not expensive, not only in relation to what MMK paid for its several acquisitions, but also compared to other recent transactions in the industry.
In 2021 Apollo acquired Reno de Medici (Italy) for a total EV of €550million: despite RDM smaller size, lower profitability and higher debt compared to MMK, that was equivalent to 0.8 EV/sales, 8x EV/EBITDA and 9x EV/EBIT. Also in 2021, Graphic Packaging (US) acquired the Swedish AR Packaging Group for US$1.4 billion, equivalent to 1.2x EV/sales, 9x EV/Adj. EBITDA and 18x EV/EBIT (which was temporarily reduced due to impairments). Finally, last year Stora Enso acquired De Jong Packaging Group (Netherlands/Belgium) to accelerate growth in renewable corrugated packaging: with an EV of €1bn, the transaction was concluded at 1x EV/sales and 9x EV/EBITDA.
Therefore, MMK can be confidently considered between fairly valued to somewhat undervalued (definitely not overvalued in my opinion). Assuming a “normalised” 9x multiple of EBITDA, in a transaction with a strategic buyer MMK could be worth up to €193 (+41% potential upside) on 2023 consensus numbers. If we believe it could go back to peak 2022 EBITDA, the target price can potentially be €258 (+88% upside).4
This target price translates to the following forward multiple on 2024 forecasts (already quite reduced from 2022):
Management & compensation
Despite the family ownership, MMK has always been run by “professional” managers.
The current CEO Peter Oswald has been in charge since 2020, when he replaced Wilhelm Hörmanseder who had been CEO for 18 years and with the group for 30 years. Peter also has more than 30 years of experience in the sector: before joining MMK he was CEO of Mondi Group since 2017, and previously he had been CEO of Mondi Packaging since 2002 and of Mondi Europe & International since 2008.
More important, over his entire stint at Mondi he has worked on integrating 60 acquisitions, a plus considering MMK’s current challenges. He will work closely with CFO Franz Hiesinger, who has been in his position since 2017 and previously worked with Peter at Mondi for 25 years.
What I’m not particularly impressed with is the remuneration of the Management Board:
In addition to some non-financial targets (reduction of occupational accidents and CO2 consumption), the annual profit-sharing bonuses are based on these three metrics: 1) EBITDA; 2) earnings per share; 3) ROCE. They do not exactly align management’s interest with that of all shareholders: the first two, in particular, encourage growth over any consideration on the return on the incremental capital invested (an acquisition can be accretive on an EPS basis and still destroy value). The third metric is slightly better, although the company’s definition of ROCE uses pre-tax operating profits rather than NOPAT in the numerator. The long-term profit-sharing plan is somewhat better, as it’s based on three-year EBIT margins.
These potential problems are evident in the total remuneration for both the CEO and CFO over the last two years, with three quarters of it from annual performance-related bonuses, mostly achieved thanks to the acquisitions:
Some (quick) conclusions
In a world dominated by AI, metaverse and Web 3.0, it’s hard to think as cartonboard as an exciting business prospect: but when you find a manufacturer with a leading competitive position, stable margins and returns on capital which is kind of overlooked by the market (undervaluing the opportunity derived from the ongoing structural shift towards sustainable packaging), investors should pay attention.
This is how MMK presents its own investment merits:
To be clear, this is a 2 to 5 years investment story (no real catalyst for a quick re-rating on the horizon): the attractiveness of MMK packaging business models remains intact, but the full-realisation of the underlying potential of the investments in acquired and organic growth will require time.
While there’s a lot of nervousness for the sudden reversal of packaging market fortunes – Stora Enso acknowledged similar challenges -, it doesn’t seem that the underlying fundamentals of packaging markets have altered and what is possibly being witnessed now is just a normalisation of the post-pandemic outbreak dash for ecommerce and essentials and, hence, resetting near-term priorities. For the long-term though, the restoration of healthy dynamics remains an inevitable outcome and, hence, what is warranted for now is the patience to navigate the brewing market challenges.
A lean business structure and effective cost controls have so far been the key in helping MMK maintain healthy operating margins at all points of the economic cycle. Sustainable benefits should continue to materialise from: 1) efficient utilisation of existing capacities; 2) long-term power purchase contracts; and 3) a gradual contribution from (inorganic) growth investments.
“Despite your focus on CapEx and integration work, do you see any potential for further acquisitions, given the current challenging market condition?
We are continually scanning the market for good add-ons, but only add-ons, not major acquisitions. Our clear priority is to improve what we already have.” (MMK’s Q1 2023 earnings call)
The cartonboard industry is characterised by intense competition and is also subject to a lot of consolidation: MMK is one of the smallest remaining producers, and a scarce asset (the only European supplier with several large production locations of both recycled and virgin fibre-based cartonboard and the only European cartonboard producer with a substantial additional pillar in folding carton production). With no legacy burden of paper assets and no ownership of fancy natural resources, it could be the target for a bigger competitor or for a private equity buyout.
So, to summarise:
Beneficiary of regulation against single-use plastics and ecommerce-driven packaging demand
Fundamentals are not so cyclical as many assume: strong underlying potential being (temporarily?) restrained by market challenges
Balance sheet strength and healthy cash generation capabilities have been put to good use with a combination of organic and inorganic growth investments
The company is not famous for its Investors’ Days or company presentations: it’s currently covered by just 6 sell-side analysts (of which only 1 from a “big” bank, Deutsche, the other 5 are all from local/second-tier brokers). Just 1 outside attendee was present at the Q1 earnings call!
Kudos for maintaining the same format (even same font!) for the annual report over the past 20 years: always the same information, no changes to the reporting structure or metrics provided (very rare, personally I’ve never seen this in other companies!)
Besides inflation concerns, the firm's material sales exposure to Eastern Europe (>30%) and work-in-progress integration of acquired assets will weigh on near-term profitability
Weakening consumer sentiment in mature markets is another (short-term?) brewing concern
Strong family control should be a deterrent for any would be acquirer
It used to be #1 in folding cartons, too, but in 2021 Graphic Packaging (US) acquired the former #2, AR Packaging Group AB (Sweden): the new combined entity became the new #1 in Europe with a market share of 14% (estimated) vs 12% for MMK.
Recycled fibres are sourced from municipalities and traders; for virgin fibres it mainly uses groundwood pulp which is also produced directly in-house at the cartonboard mills.
Nothing too complicated despite the menacing name: it’s just a privately placed, typically unsecured medium to long-term debt obligation governed by German law, which fundamentally comprises of a loan agreement and a certificate of indebtedness evidencing such loan agreement. Schuldscheine are considered a hybrid financial product, somewhere in between a syndicated loan, a privately placed bond and a loan participation note.
Here is my back-of-the-envelope calculation:
€600m (2023e EBITDA) x 9x = EV €5,400m – net debt €1,535m = equity value €3,865m / 20m shares —> €193/share
While very imperfect, EBITDA multiples are commonly used in M&A transactions: a 9x multiple for MMK can also be justified by the following formula:
ROIC = 12%
g = 4%
WACC = 9%
T (taxation) = 27%
D (depreciation as a % of sales) = 5%