Pactiv Corp. (PTV) delivered earnings per share of 56 cents in its second quarter ended June 30, 2010, inching past the Zacks Consensus Estimate by a penny. The EPS was at the high end of management’s guidance of 52─56 cents and, on a year-over-year comparison, dropped 8% from 61 cents. Weak volumes at Hefty Consumer Products and unfavorable spreads offsett volume growth at Foodservice/Food Packaging, partly mitigated by the accretion from the PWP Industries acquisition and lower selling, general and administrative spending, resulting in the year-over-year decline.

Pactiv Corp.’s total revenue of $973 million fell short of the Zacks Consensus Estimate of $1.008 billion. On a year-over-year basis, revenues grew 8% driven by higher volumes of 7%, higher pricing of 1% and synergies from the acquisition of PWP Industries that added $41 million to revenues. Volume growth was driven by the addition of PWP as well as new business wins. 

Costs & Margin Performance

Cost of sales increased 16% year over year to $699 million and, as a percentage of revenues, climbed 510 basis points to 71.8% in the quarter. Gross profit thus declined 9% to $274 million and gross margin fell 50 basis points to 28.2%.

Selling, general and administrative expenses (SG&A) however, declined 17% year over year to $83 million and, as a percentage of sales, dropped 260 basis points to 8.5%. The substantial drop was due to lower incentive compensation accruals. Operating income went down 8% year over year to $141 million with operating margin declining to 14% from 17% in the year-ago quarter.

Segment Performance

On the revenue front, the Foodservice/Food Packaging segment fared comparatively better with revenues increasing 12% to $612 million driven by volume growth of 10% and a 2% higher pricing. Further, PWP Industries’ revenues were also included in the segment’s sales. Cups and cutlery, produce packaging, processor trays, and paper-based items exhibited growth offsetting declines in some traditional product lines, such as carry-out containers.

The segment’s operating profit dropped 10% year over year to $69 million and segment margin dipped 280 basis points to 11.3% due to an unfavorable spread.

Revenues at Hefty Consumer Products inched 1% year over year to $361 million. Volume growth was a meager 1% as volumes were weak at all of the segment’s product categories. The only saving grace was the new business in store brand waste bags, which somewhat helped offset the weak volumes.

The company had implemented higher pricing to combat rising raw material costs. However, contrary to expectations, raw material costs declined sequentially in the middle of the quarter, leading to some lost volume on non-competitive pricing.

The segment’s operating income was $74 million, an 8% drop from $80 million in the year-ago quarter. Operating margin contracted 200 basis points to 20.5%. Unfavorable spread as well as product mix offset benefits from lower SG&A spending.

Financial Position

As of June 30, 2010, Pactiv Corp. had cash and cash equivalents of $43 million, substantially down from $235 million as of March 31, 2010. During the quarter, the company closed the acquisition of PWP Industries for $200 million, which dented its cash balance. 

The company generated cash flow from operating activities of $81 million compared with $99 million in the year-ago quarter.

As of June 30, 2010, the debt-to-capitalization ratio was 57% compared with 60% as of March 31, 2010.

In April 2010, the company closed the acquisition of PWP Industries, a leading manufacturer of APET (amorphous polyethylene terephthalate) disposable products. PWP primarily manufactures a range of APET foodservice containers for several channels, including packer processor bakeries, supermarkets and quick service restaurants. It operates three manufacturing facilities in the United States as well as a facility that processes post consumer PET (polyethylene terephthalate).

Outlook

The company expects third-quarter EPS to be in the range of 56 cents to 60 cents, reflecting increased advertising and promotion spending in support of the Consumer business.

Pactiv Corp. narrowed its fiscal 2010 EPS guidance range to $2.15 ─$2.30 from its previous expectation of $2.10─$2.30. The guidance includes non-cash pension income of $48 million pretax, $30 million after tax, or 23 cents per share.
 
Revenue in 2010 is expected to increase between 8% and 9% driven mainly by volume growth of 9% to 10%, as pricing is expected to be flat compared with 2009. The guidance has been trimmed from the previous expectation of 10% to 12% growth given the slow recovery in the overall market. Further, due to a lower raw material cost outlook, the magnitude of selling price increases will be lower in the second half.

Expenses from selling, general and administration are projected in the range of $305 million to $315 million. The tax rate is expected to be 36.5%. The company expects to generate free cash flow in the range of $330 million to $350 million. Depreciation and amortization expense is expected to be approximately $195 million, and capital expenditures are estimated to be approximately $130 million.

Our Take

The company’s profits have declined in the first two quarters of 2010. However as employment picks up and eating-away-from-home trends strengthen, demand will improve for many of the company’s core product lines that have been hurt by the downturn.

Pactiv Corp. is expected to deliver earnings growth in the back half of 2010 due to synergies associated with its acquisition of Prairie Packaging Inc., a leading manufacturer of disposable tableware products, and its recent acquisition of PWP Industries. Additional share buybacks, strategic acquisitions and deleveraging of its balance sheet could buoy the stock.

However, volatile raw material prices and the uncertainty regarding the buyout stories by privately held conglomerate Koch Industries and private-equity firm Apollo Global Management remain points of concern.

Lake Forest, Illinois-based Pactiv Corporation engages in the manufacture and sale of consumer and foodservice/food packaging products in the United States and internationally. Pactiv operates through two segments: Hefty Consumer Products and Food Service/Food Packaging products. Its well known Hefty brand products include waste bags, slider storage bags, disposable tableware and disposable cookware.

 
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