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Owens-Illinois Rides on Successful JV, Rising Expenses a Woe

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On Mar 5, we issued an updated research report on Owens-Illinois, Inc. (OI - Free Report) . The company will benefit from the extension and expansion of joint venture (JV) with Constellation Brands, Inc. (STZ - Free Report) , acquisition of Vitro's food and beverage business and strategic initiatives. However, higher supply chain and restructuring costs in Asia Pacific as well as higher interest expenses will dent results in the near term.
 
Q4 Results Deliver Y/Y Improvement
 
Owens-Illinois delivered fourth-quarter 2017 adjusted earnings of 55 cents per share, up 10% year over year and also ahead of the Zacks Consensus Estimate of 52 cents. The uptick primarily reflected the benefits of the company’s global focus on reducing Total Systems Costs (“TSC”). Net sales were up around 4% year over year to $1.71 billion but fell short of the Zacks Consensus Estimate of $1.72 billion. The improvement in net sales can be attributed to a 1% increase in price on a global basis and favorable currency translation. Global sales volumes were flat from the prior-year quarter.
 
Fiscal 2018 View Upbeat
 
Overall in 2018, positive trends in volumes and focus on TSC will likely lead to higher earnings and cash flow. The company is improving productivity across all businesses, functions, processes and geographies. Its focus on TSC contributed approximately $39 million during 2017. The company guides adjusted earnings in the range of $2.75-$2.85 per share for 2018. The mid-point of the range reflects a 6% year-over-year improvement with all regions projected to be more profitable and expand margins. This is anticipated to generate high-single digit growth in segment operating profit and contribute at least 40 basis points of margin expansion.
 
Successful JV with Constellation to Drive Growth
 
Owens-Illinois continues to mitigate the impact of the ongoing decline in mega beer in the United States by positioning itself to benefit from the rapidly growing market of U.S. beer imports.  It intends to achieve this through its JV with Constellation Brands and long-term sales contracts in Mexico. The company’s extension of the 50-50 JV with Constellation Brands for an additional ten years (to 2034) and expansion to include an additional furnace will be earnings accretive in the future. The JV was formed in 2014 and currently operates a glass container production plant in Nava, Mexico. The plant provides bottles exclusively for Constellation’s adjacent brewery, which brews a leading portfolio of Mexican beer brands for export to the United States, the fastest growing category in beer in the country.
 
The JV has three furnaces currently in operation and the fourth to be operational in first-half 2018. The JV has exceeded expectations so far — productivity has been higher than expected, capital costs were considerably less than initially anticipated and earnings have been growing every year. To cater to the rising demand from Constellation`s adjacent brewery, the newly-expanded relationship will now add a fifth furnace, which is anticipated to be operational by the end of 2019. With the installation of the fifth furnace, the Nava plant will be the largest, most modern glass container factory in the world.
 
 
Owens-Illinois has outperformed the industry with respect to share price performance in the past year. The stock gained 8% in congtrast to the industry’s decline of 3%.
 
Higher Expenses to Remain Headwinds
 
Earnings will be affected by few headwinds in 2018. Corporate expense is anticipated to be $115-$120 million due to investments and capability building, focus on technology and products innovation. The company also lowered assumption of the expected rate of return on pension assets globally by about 50 basis points, leading to an incremental $8 million in pension expense in 2018.
 
In Colombia, the company plans to shut down one plant and presently consolidating capacity at another plant within the country. The return on investment is substantial. However, in 2018, the region will bear an incremental $10 million headwind from production downtime, direct expense, and ramp up cost before generating higher earnings and cash in 2019.
 
Further, interest expense is likely to be higher due to higher variable rates in the United States and the strengthening euro. Despite Owens-Illinois’ deleveraging and refinancing actions in the past 12 months, its debt-to-capitalization ratio remains high at 85%. This is a concerning factor.
 
Increased Supply Chain Costs in Asia-Pacific 
 
Despite favorable market trends in Asia-Pacific, sales growth has not translated to the bottom line due to ongoing downtime from repair activity, changing customer needs and increasing the supply chain complexity. To meet the customers demand, Owens-Illinois has begun to shipment from where it was readily available. This has in turn, increased supply chain costs impacting the bottom line. To address the situation, the company began substantial asset investments in the fourth quarter of 2017 to improve the supply chain scenario. These activities will continue into early 2018 and is expected to temporarily affect earnings in the region.
 
Owens-Illinois currently carries a Zacks Rank #3 (Hold).
 
Some better-ranked stocks in the sector include Komatsu Ltd. (KMTUY - Free Report) and H&E Equipment Services, Inc. (HEES - Free Report) . While Komatsu sports a Zacks Rank #1, H&E Equipment Services carries a Zacks Rank #2. You can see the complete list of today's Zacks #1 Rank stocks here
 
Komatsu has a long-term earnings growth rate of 32%. The stock has gained 38% in a year’s time.
 
H&E Equipment Services has a long-term earnings growth rate of 14%. Its shares have soared 62%, over the past year.
 
Caterpillar has a long-term earnings growth rate of 10%. The company’s shares have rallied 58% in last year.
 
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