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Sonoco Products Co.’s (SON - Analyst Report) second-quarter 2012 adjusted earnings were 58 cents per share compared with 60 cents in the year-ago quarter, lying between the previous guidance range of 55 cents to 60 cents. Earnings were in line with the Zacks Consensus Estimate.

The quarter excluded a tax charge of 8 cents per share stemming from restructuring activities and impairment costs. The year-ago quarter excluded some special items including restructuring and impairment charges amounting to 7 cents per share and 1 cent per share pertaining to other adjustments. Inclusive of these one-time items, earnings amounted to 50 cents per share in the reported quarter versus 52 cents in the year-ago quarter.

Net sales increased 6.6% to $1.20 billion, missing the Zacks Consensus Estimate of $1.22 billion. The improvement in sales was attributable to the acquisition of Tegrant Corp., partially offset by lower volume and currency translation effect.

Costs and Margins

Cost of sales increased 5.2% to $985.8 million in the reported quarter. Gross profit at Sonoco increased 13.3% to $216.5 million, expanding gross margin by 110 basis points (bps) to 18%.

Selling, general and administrative expenses increased 19.4% to $118.6 million in the quarter. Sonoco’s adjusted operating income increased 5.7% to $98.1 million in the quarter from $92.8 million in the year ago quarter. Operating margins remained flat year over year at 8.2%.

Segment Performance

Net sales at the Consumer Packaging segment declined 2.8% to $477.0 million. The decline was brought about by unfavorable currency translation and lower volume of composite can business, offsetting the positive impact of higher selling prices.

Operating profit of the segment, however, increased 6.3% to $42.8 million. The increase was driven by a positive price-cost relationship that more than offset the higher pension cost, labor cost, other expenses and negative volume. Consequently, operating margin expanded 80 bps to 9% in the quarter.

Net Sales at the Paper and Industrial Converted Products segment decreased 2% to $475 million due to lower recovered paper price and currency translation.

Operating profit at the segment decreased 2% to $39.7 million. Operating profit declined because of higher pension expenses, labor expenses and other costs partially offset by productivity gains and positive price/cost mix. Operating margins remained flat year over year at 8.3%.

Packaging Services segment's net sales declined 16.6% to $107.8 million from $125.9 million in the year-earlier quarter. The decline was driven by negative currency translation, loss of contract packaging customers offsetting the improvement in global fulfillment activities.

Operating profit dropped 116.5% to $4.0 million in the quarter, driven by lower volumes, higher pension expenses and lost contract packaging customer. Accordingly, operating margins decreased 320 bps year over year to 3.7%.

Protective Packaging reported that net sales increased to $142.1 million. The increase was driven by Tegrant acquisition.

Operating profit at the segment jumped up 238.2% to $11.7 million as a result of the acquisition of Tegrant. However, operating margins contracted 490 bps year over year to 8.2% in the quarter.

Financial Position  

As of July 1, 2012, cash and cash equivalents were $196.0 million, up from $176.1 million as of April 1, 2012. Cash flow from operating activities were $42.9 million during the first quarter of 2012 compared with $45.9 million in the prior year quarter.

The company’s debt-to-total-capital ratio increased to 47.4% as of July 1, 2012, compared with 45.8% as of April 1, 2012.

Outlook

Sonoco guides its third quarter earnings in the range of 62 cents to 66 cents. The company revised the full year earnings guidance in the range of $2.34 to $2.39 from the previous guidance of $2.34 to $2.44.

Our View

The company’s second quarter performance was affected negatively by the soft global economic conditions, higher pension related expenses and foreign currency translation. Net sales in all the segments except Protective Packaging declined year over year, driven by higher expenses and negative currency translation.

Going forward, the company would be benefited by the Tegrant acquisition and positive price-cost mix. However, weak macroeconomic condition will be a headwind for the company moving forward.

Sonoco competes with the companies like Bemis Company, Inc. (BMS - Analyst Report) and Rock-Tenn Co. (RKT - Analyst Report). Sonoco retains a short-term Zacks #4 Rank (Sell). We have a long-term Neutral recommendation on the stock.

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