Recently a Member of our Inner Circle asked Pat McKeough’s advice on a company that’s been on an acquisition spree to bolster its growth.

Crown Holdings supplies beverage cans and other packaging products to major beverage firms worldwide. Growth has come from expanding its facilities as well as several large acquisitions in Europe, Latin America and other key markets. Pat notes that revenues have been flat due to unfavorable exchange rates, but the latest acquisition appears to be paying off. Still, high debt levels can pose a risk.

Q: Hello Pat: What is your opinion on Crown Holdings? Thanks.

A: CROWN HOLDINGS  (symbol CCK on New York; www.crowncork.com) formerly Crown Cork & Seal Company, is a worldwide leader in the design, manufacture and sale of metal beverage and food cans, metal aerosol containers, metal closures and specialty packaging. The company operates 143 plants, along with sales and service facilities in 36 countries. It has about 24,000 employees.

In 1892, the founder of the company, William Painter, invented the bottle cap (also known as the crown cork).

Crown supplies beverage cans and other packaging products to companies, including Anheuser-Busch InBev, Coca-Cola, Cott Beverages, Dr Pepper Snapple Group, Heineken, Molson Coors, and PepsiCo. Its food-cans business supplies companies such as Abbot Laboratories, Bonduelle, Cecab, Morgan Foods, Nestlé, Princes Group, and Simmons Foods. The company’s aerosol cans go to companies such as Friesland Campina, Procter & Gamble, S.C. Johnson, and Unilever.

Beverage cans account for 58% of Crown Holdings’ overall sales, while food cans account for 27% and aerosol cans account for the remaining 15%.

Geographically, 44% of the company’s revenues come from the Americas (North and South), 42% from Europe and 14% from Asia.

Crown has grown by expanding its existing facilities, but also through several large acquisitions.

In 2014, the company paid $1.20 billion for Mivisa, the largest food-can producer for both the Iberian Peninsula (Spain and Portugal) and Morocco. The acquisition substantially increased the company’s presence in Europe.

In 2015, Crown acquired Empaque, a Mexican manufacturer of aluminum cans, bottle caps and glass bottles, for $1.23 billion. The firm is one of the top 10 global beverage can producers, and with this acquisition, Crown became Mexico’s largest beverage-can producer. Long-term supply agreements with Heineken affiliates were part of the deal.

In April 2018, Crown completed the acquisition of Signode Industrial Group, for $3.91 billion. Signode will add annual revenue of $2.4 billion; it currently operates 88 manufacturing facilities across six continents. It is also a leader in transit packaging systems, which consist of strap, stretch and other protective packaging.

Signode products secure and protect industrial and consumer goods during warehousing and shipment. The business caters to manufacturing firms working in the primary metals, food and beverage, construction, and agricultural industries.

Growth stocks: Risky debt levels could hinder growth

This year, Crown will expand its existing production facilities in Yangon, Myanmar, and in Phnom Penh, Cambodia. The facility in Valencia, Spain, will be retooled to produce aluminum for beverage cans instead of steel ones.

Despite the acquisitions of Mivisa and Empaque, the company’s overall revenues have remained relatively flat over the past five years. This was primarily due to unfavourable exchange rates because of a stronger U.S. dollar. From $8.66 billion in 2013, revenue climbed 5.1% to $9.10 billion in 2014; it then dropped 3.7%, to $8.76 billion in 2015 and another 5.5%, to $8.28 billion in 2016. In 2017, revenue rose 5.1%, to $8.70 billion. Crown’s earnings, excluding one-time items, rose 12.2%, from $3.07 in 2013 to $3.41 in 2014. Following 2014, earnings moved up just 18.5% to $4.04 for 2017.

In the three months ended June 30, 2018, revenue jumped 41.0%, to $3.05 billion from $2.16 billion a year earlier. The increase was due to the Signode acquisition. Earnings in the latest quarter, excluding one-time items, were up 30.2%, to $207.0 million, or $1.55 a share, from $159.0 million, or $1.17.

Crown faces a number of challenges. The biggest is its debt level due to acquisitions. On June 30, 2018, the company’s long-term debt stood at $9.24 billion, or a very high 162% of its market cap. That adds a lot of risk.

In addition, growth-by-acquisition is inherently risky since it carries an above-average chance of unpleasant surprises. Generally, a buyer of something rarely knows as much about it as the seller. If you make enough acquisitions, you are bound to buy something with hidden problems. Eventually, those problems come out in the open and hurt the acquirer’s earnings.

Crown also faces increased costs for freight and raw materials. While that has hurt the company’s profits, it has also hurt earnings for its competitors. As a result, they all will likely pass on their higher costs to customers.

Meanwhile, Crown has expanded its operations into promising markets. Additionally, it should be able to use its steady earnings to gradually pay down its debt.

The stock now trades at just 8.1 times the forecast 2018 earnings of $5.23 per share.

Inner Circle recommendation: Crown Holdings is okay to hold, but only for aggressive investors.

What to Read Next 

Money moving stock moves to digital

Always a bad time for market timing