Pactiv's EPS Misses, Revenue Beats - Analyst Blog

Pactiv Corp. (PTV) delivered earnings per share of 43 cents in its third quarter ended September 30, 2010, falling short of the Zacks Consensus Estimate of 56 cents. On a year-over-year comparison, EPS dropped 27% from 59 cents. Hike in raw material costs as well as in operating costs related to the start-up of new production processes and equipment offset a volume growth and benefit from the PWP acquisition.

Adjusted EPS in the quarter included approximately 16 cents per share benefit from a tax liability adjustment related to the expiration of the U.S. federal tax statute of limitations for 2006. Including this, EPS in the quarter stood at 59 cents, on par with the year-ago quarter.

Pactiv Corp.'s total revenue of $944 million, however, surpassed the Zacks Consensus Estimate of $937 million. On a year-over-year basis, revenues grew 12.5% driven by higher volumes of 11%, higher pricing of 1% and synergies from the acquisition of PWP Industries that added $42 million to revenues.

Costs & Margin Performance

Cost of sales surged 24% year over year to $696 million in the quarter; based on revenues, cost of sales climbed 670 basis points to 73.7% in the quarter. Gross profit thus declined 10% to $248 million and gross margin plunged 670 basis points to 26.3%.

Selling, general and administrative expenses (SG&A) increased 1% year over year to $84 million and, based on sales, increased 100 basis points to 8.9%. Operating income went down 21% year over year to $117 million with operating margin contracting 520 basis points to 12.4% in the quarter.

Pactiv's margins were affected in the quarter by an unfavorable spread (the difference between selling prices and raw material costs) and higher operating costs, offset by the benefits from higher volume and productivity and cost reduction programs.

Segment Performance

On the revenue front, the Foodservice/Food Packaging segment fared better with revenues increasing 16% to $611 million driven by volume growth of 12% and a 4% 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 12% year over year to $64 million and segment margin dipped 340 basis points to 10.5% due to an unfavorable spread and higher operating costs.

Revenues at Hefty Consumer Products upped 7% year over year to $333 million. The segment recorded a volume growth of 9% reflecting increases in branded and private label waste bags, partially offset by declines in some other product lines. The segment's operating income was $58 million, a 28% drop from $80 million in the year-ago quarter. Operating margin plummeted 820 basis points to 17.4%.

Financial Position

As of September 30, 2010, Pactiv Corp. had cash and cash equivalents of $52 million, up from $43 million as of June 30, 2010. The company generated cash flow from operating activities of $135 million compared with an outflow of $21 million in the year-ago quarter. Free cash generated during the quarter was $100 million compared with an outflow of $31 million in the year-ago quarter.

As of September 30, 2010, the debt-to-capitalization ratio improved to 54% compared with 57% as of June 30, 2010.

Our Take

The company's profits declined in the first three 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 remain a point of concern. We currently have a Zacks #3 Rank (short-term Hold recommendation) on the stock.

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.