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Sonoco Products Co. (SON - Analyst Report) recently reported its second-quarter results delivering an EPS of 52 cents versus 58 cents in the year-earlier quarter. The quarter noted some special items including restructuring and impairment charges amounting to 7 cents and a cent pertaining to other adjustments.

Excluding these one-time items, adjusted EPS amounted to 60 cents versus 59 cents in the year-ago quarter, failing the Zacks Consensus Estimate of 63 cents.

The earnings were more or less flat compared with last year; the company witnessed weaker-than-expected results in its industrial and consumer businesses.

Net sales increased to $1.13 billion in the reported quarter from $1.01 billion in the prior-year quarter. Though volume growth was modest, productivity improved marginally.

Costs and Margins

Sonoco reported cost of sales of $936.8 million in the reported quarter compared with $817.6 million in the year-ago quarter. Gross profit at Sonoco declined slightly to $191.1 million versus $192.5 million in the year-earlier quarter, thereby contracting gross margins by 220 basis points year over year to 16.9%.

Selling, general and administrative expenses decreased slightly to $99.3 million from $99.76 million in the year-ago quarter. Sonoco reported operating income of $82.2 million, a decline from $90.4 million in the year-earlier quarter. Consequently, operating margins also decreased 160 basis points year over year to 7.3% in the quarter.

Segmental Performance

Net sales at Consumer Packaging segment increased to $450.8 million in the quarter from $392.5 million in the year-ago quarter. However, operating profit of the segment decreased to $35.0 million from $42.1 million in the year-ago quarter, thereby contracting operating margins by 290 basis points year over year to 7.8% in the quarter.

Increase in sales was mainly due to last year’s acquisition of Associated Packaging Technologies Inc., higher selling prices and favorable currency translation. Volume growth in flexible packaging and rigid plastic containers was partially offset by declines in rigid paper containers and closures.  Operating profit dwindled due to negative cost-price relationship, change in business mix and higher labor costs.

Total revenue of Tubes and Cores/Paper segment soared to $455.8 million from $415.6 million in the prior-year quarter. Operating profit of the segment also increased $37.2 million from $36.9 million in the previous- year quarter. Consequently, operating margins also dropped 120 basis points year over year to 8.2%.

The increase in sales is attributable to higher selling prices and favorable currency translation. Operating profit was more or less unchanged as productivity improvements were negligible. Lower pension expense and cost reductions were offset by negative price/cost relationship, wrong timing of contract resets and change in the mix of businesses.

Packaging Services segment reported total revenue of $123.8 million, up from $113.8 million in the year-ago quarter. Operating profit more than doubled to $8.2 million from $$3.5 million in the previous year's quarter. Consequently, operating margins increased 360 basis points year over year to 6.7% in the quarter.

The sales increase was mainly driven by improved volume in contract packaging and point-of -purchase displays and favorable currency translation. The operating profit increased drastically due to improved volumes.

All Other Sonoco segment reported net sales of $97.5 million, up from $88.2 million in the year-earlier quarter. Operating profit of the segment surged to $12.3 million from $10.3 million in the year-earlier quarter. Consequently, operating margins increased 100 basis points year over year to 12.6% in the quarter.

Improvement in sales was driven by volume gains in molded plastics and reels and spools, higher selling prices and sales from a small acquisition. Operating profit improved due to productivity gains.

Financial Position

As of July 3, 2011, cash and cash equivalents were $134.0 million, declining from $158.2 million as of December 31, 2011.

Cash from operating activities increased to $45.9 million during the quarter from $41.6 million during the previous year’s quarter.

The company’s debt-to-total-capital ratio improved to 30.9% as of July 3, 2011 from 33.1% at the end of first quarter 2011 and 29.2% at the end of 2010.

Outlook

Sonoco guides third quarter EPS in the range of 64 cents to 68 cents; while full year EPS is guided in the range of $2.46 to $2.54.

Our Take

We believe Sonoco’s strategy to grow through acquisitions, potential restructurings and increased focus on emerging markets will certainly bring long-term benefits. However, raw material inflation, high customer concentration and a still fragile construction industry will affect its financial results in the near term. We currently have a Zacks #4 Rank (short-term Sell recommendation) on the stock.

Hartsville, South Carolina-based Sonoco is a global manufacturer of consumer and industrial packaging products. The company has more than 300 operations in 35 countries throughout North and South America, Europe, Australia and Asia.

It operates through four reportable segments: Tubes and Cores/Paper, Consumer Packaging, Packaging Services and All Other Sonoco segment. Sonoco competes with Bemis Company Inc. (BMS - Analyst Report) and Rock-Tenn Co. (RKT - Analyst Report).

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