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WIKI ANALYSIS
Owens-Illinois (OI) is the world's largest glass bottle manufacturer by revenue. OI's customers are primarily alcoholic beverage companies, although it also produces bottles for soft drink producers as well[1]. Notable clients include Anheuser-Busch Companies (BUD) , H.J. Heinz Company (HNZ), and Pepsico (PEP).
Until the beginning of 2008, the company also had the dubious honor of being one of the worst performing bottle manufacturers, with operating margins consistently below its peers. A combination of debt, rising commodity prices and litigation, led to several years low operating margins and net earnings losses.
- In 2007, the company had over $5B in debt and $500MM in annual interest payments. The company sold its Plastics Packaging Division in mid 2007 and used the proceeds to pay down some of its debt reducing its interest payments to $350 million.
- Natural gas, used to fire glass making furnaces, represents between 15%-25% of OI's manufacturing costs.[2] Historically, glass bottle manufacturers have found it difficult to pass on price increases to their customers. [3] OI, however, has made it a point to decrease the number of long-term contracts without provisions for price increases and grow the number of contracts with pass through provisions. While this has negatively impacted the company's volume, it has led to higher margins. OI also implemented a more aggressive hedging program (hedging approximately 50% of its expected natural gas consumption).
- From 1948-1958 the company produced asbestos based insulation. Since 1993, the company has been plagued by ongoing lawsuits over asbestos poisoning. At the end of 2007, the company expected to have to pay up to $3.2B in damages by the time the litigation runs it course. The company accrues or sets aside a portion of its revenue each year in preparation for the damages that it will eventually have to pay, reducing net income.
Business Financials
From 2002 to 2007, OI's reported earnings have been negative three out of the five years. This is largely due to the annual interest it pays on its debt which, as of mid 2007, amounted to $5 billion. Its operating margins are also considerably lower than its competitions': %6 compared to %8, partly because of interest related costs.
OI has focused on implementing its European restructuring program, effectively establishing a single manufacturing headquarters in Switzerland to replace those previously located throughout Europe. In July of 2007, OI sold its Plastics Packaging Davison to Rexam (REXMY) for $1.8 billion. The $1.8 billion in revenue resulting from the sale was used reduce the $5 billion OI owed in early 2007 to $3.7 billion, thereby reducing interest owed and increasing profitability. [7] After the sale of its Plastics Packaging Division, OI was able to reduce its interest payments to approximately $348.6MM.[8]
The combination of these measures helped OI to reap a 13.59% growth in net income in 2007.[9]
Another source of lost earnings to Owens-Illinois is related to the number of asbestos related claims placed on it by former employees, with total pending claims numbering 24,000 as of 2006. OI reported that in 2007, asbestos related costs amounted to $115 million and materially affect the company's operations.[10] The company claims that of the approximately 361,000 plaintiffs and claimants who had sought compensation for asbestos exposure from the company, the average claim paid was $6,900.[11] Based on study of the cases pending as of December 31, 2007, fewer than 1% of the plaintiffs claims totaled more than $100 million, and all amounted to less than $123 million. %89 of plaintiffs either did not specify a claim amount or specified enough to satisfy the jurisdictional minimum of the court. The company also notes that despite its continued study of current trends in asbestos litigation trends, future costs are ultimately unpredictable.[12]
Trends and Forces
Natural Gas Costs 15% to 20% of Production Costs
Asbestos Claims Reduce Earnings
From 1948 to 1958 OI included a division that produced asbestos based insulation, exposing many former employees to asbestos during the manufacturing process. Claims have been placed on the company by former employees exposed to the asbestos with and without asbestos related medical conditions, as well as by family members and relatives of deceased workers. Liability for asbestos related claims (including legal fees) accrued as of 2007 amounted to approximately $3.22 billion.[16] Costs related to asbestos claims have been significant in the past and OI expects them to be both substantial and unpredictable in the future, designating $115 million in 2007 to increase the accrual for predicted asbestos related costs. It states that the use of mass litigation, as well as the claims made by parties exposed to asbestos but not suffering from related medical conditions are increasing. With new claims directed at other former asbestos manufacturers used as legal precedents, the scope of both eligible defendants and claim amounts have increased and affect earnings of OI directly. [17]
Interest Rates Affect Company Leverage and Financial Maneuverability
With approximately $3.7 billion in debt, 62% of which has been borrowed on variable interest rates, OI faces higher costs associated with higher real interests rates than would similar companies with less debt. In 2006, before the OI Plastics Division was sold, interest payments totaled $349 million, and it is estimated that payments will be reduced by $150 million in 2008. The company has no assurance that it will be able to pay debt or find creditors in the future, even after assets have been sold or refinancing options have been pursued.[18]
Glass Industry Market Share
Competition
Although OI maintains the greatest market share in glass bottle production worldwide, its competition is not limited to other glass packaging producers. As its clientele is primarily composed of beverage producers that also package beverages in plastic or aluminum containers, OI's competition includes manufacturers of these substitute goods. The capital intensive nature of the glass manufacturing industry restricts the entry of new firms into the industry; annual revenue per worker is approximately $200,000.[22]
Glass Producers: These firms compete directly with Owens-Illinois.
- Saint-Gobain
- Weignad
- Ardagh
- Rexam (REXMY)
- Allied Glass
- Quinn
Substitute Material Producers: These firms produce materials needed for alternative beverage packaging such as aluminum cans, plastic bottles, or cartons.
- Alcoa (AA)
- AptarGroup (ATR)
- Crown Holdings
- Portola Packaging
- Erie Plastics
References
- ↑ "OI 2008 10K, pg. 1"
- ↑ "OI 2008 10K, pg. 12"
- ↑ Analyst Note, Morning Star Analyst Report 5-12-2008
- ↑ "OI 2008 10K, pg. 32"
- ↑ "OI 2008 10K, pg. 49"
- ↑ "OI 2008 10K, pg. 92"
- ↑ "Eye on Owens-Illinois, Seeking Alpha, May 06, 2008"
- ↑ "OI 2008 10K, pg. 49"
- ↑ "Eye on Owens-Illinois, Seeking Alpha, May 06, 2008"
- ↑ "OI 2008 10K, pg. 9,10"
- ↑ "OI 2008 10K, pg. 90"
- ↑ "OI 2008 10K, pg. 89"
- ↑ "Industrial Sector Research Owens-Illinois, KeyBanc Capital Markets, January 2007, pg. 21
- ↑ "OI 2008 10K, pg. 12"
- ↑ "Industrial Sector Research Owens-Illinois, KeyBanc Capital Markets, January 2007, pg. 20
- ↑ "OI 2008 10K, pg. 9"
- ↑ "OI 2008 10K, pgs. 9,10"
- ↑ "OI 2008 10K, pg. 10,21"
- ↑ "Industrial Sector Research Owens-Illinois, KeyBanc Capital Markets, January 2007, pg. 18
- ↑ "Industrial Sector Research Owens-Illinois, KeyBanc Capital Markets, January 2007, pg. 18
- ↑ "Industrial Sector Research Owens-Illinois, KeyBanc Capital Markets, January 2007, pg. 18
- ↑ "Hoover's Industry Overview: Glass and Fiber Optic Manufacturing"
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