Ranpak Holdings: The Case For A Busted Pandemic Winner
A stunning round-trip might have gone a bit too far.
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On Wednesday, we talked about buying risk, and highlighted some intriguing plays that qualified. Packaging provider Ranpak Holdings (PACK) didn’t make the cut then — but it does now.
A key reason why we kept PACK off the list was that earnings were on the way, and from a distance looked dicey. That judgment proved correct: Ranpak tanked its Q2 report on Thursday morning, and PACK plunged 23% in response. The decline completed an absolutely epic round-trip:
The return to 2019 lows on its own doesn’t make the stock a buying opportunity. Nor is the chart that outlandish in the context of pandemic winners.
Ranpak, a play on e-commerce growth, indeed saw its growth boosted by the pandemic. And its chart looks similar to that of one of the biggest pandemic winners (and post-pandemic losers), Peloton Interactive (PTON):
The broad risk for PACK stock is that it winds up looking like PTON, which has not only round-tripped but fallen well below pre-pandemic levels. It’s not impossible that PACK follows a similar pattern. Ranpak’s Q2 earnings were ugly. Leverage is significant, and a potential mid-term concern.
We should also point out that one of the stocks discussed on Wednesday was Avaya Holdings (AVYA), which promptly dropped 57% on Friday after an ugly report of its own. Leveraged falling knives are dangerous. Timing, patience, and risk tolerance are paramount here.
With those caveats, however, this is an intriguing story. The long-term case for Ranpak isn’t broken. Balance sheet risk seems manageable. Valuation is attractive in a historical context. Ranpak isn’t what investors believed it was a year ago, certainly — but at $5 it doesn’t have to be.
Ranpak At A Glance
Founded in 1972, Ranpak manufactures systems which in turn are used to create paper-based packaging for protection during shipping, as well as automated solutions for both packaging and box-sizing. The systems — 136,500 at the end of Q2 — mostly are leased out to end users for a small fee; through a razor and blade model. Ranpack then profits from delivering the paper consumables. The company has leading market share in paper-based packaging.
That packaging falls into three categories. Void-fill, as the name suggests, uses paper to fill empty space within a box, limiting movement of and damage to objects in transit. Cushioning products are created by crimping paper to create air bubbles. Wrapping products include paper mesh as well as cold chain products, used for refrigerated transport. In 2021, void-fill drove ~40% of revenue, cushioning ~42%, and wrapping ~14%, with the remainder coming from automated equipment and accessories.
Major customers include Amazon.com (AMZN), Walmart (WMT), Ikea, and many more; overall, Ranpack has end users in some 50 countries. 38% of 2021 revenue came from North America, 12% from Asia/EMEA, and — notably — half from Europe.
Ranpack went public in 2019 via a SPAC (special purpose acquisition corporation) merger. JS Capital, run by Jonathan Soros, son of George, owns 37.5% of the company.
The High-Level Bull Case
That description highlights two core pillars of the long-term bull case. Ranpak is an obvious play on e-commerce growth; most readers no doubt have encountered its packaging in the wild. It’s also a play on sustainability, given both the ability of its packaging to be recycled (unlike, for example, styrofoam), and the fact that recycled materials are used in its consumables (over half of raw supply is recycled paper).
This also has been an awfully good business over time, as growth has been consistent, if not quite spectacular:
source: Ranpak SPAC presentation, December 2018
EBITDA margins cleared 30% in 2021, and conversion of EBITDA to free cash flow historically was rather strong.
The Pandemic Roller-Coaster
Unsurprisingly, that bull case was greeted with optimism after the novel coronavirus pandemic hit. E-commerce growth led machine placements to rise double-digits in both 2020 and 2021. Last year, revenue increased 28.7% (26.3% on a constant-currency basis), with Adjusted EBITDA margins essentially flat. PACK stock ended 2019 at $8.15, below its $10 merger price; at the early 2021 peak the stock had more than quintupled.
Again, this was a classic pandemic winner. And, like so many pandemic winners, 2022 has been rough for both the business and the stock.
In the Q4 release in February, Ranpak gave constant-currency guidance for revenue growth of 13% to 18%, and Adjusted EBITDA of $128 to $132 million (+9% to +12%). After Q1, Ranpak moved to the lower end of the top-line outlook, and cut the midpoint of its EBITDA guidance by about 10%.
Following Thursday’s report, however, the news got much worse. Ranpak now sees sales declining even in constant currency. Adjusted EBITDA now is pointed to $75 to $85 million — but even that understates the case. As an analyst pointed out on the call, currency effects (notably the weaker euro) suggest a ~$5 million hit.
As reported, then, Adjusted EBITDA is guided down about one-third year-over-year. Even assuming that guidance is hit — and after the last two quarters, investors would be forgiven for not wanting to assume anything — Ranpak should close the year with a net leverage ratio over 4x. At the midpoint of guidance, shares trade at almost 10x EV/EBITDA, which given the growth profile hardly seems like an attractive multiple.
Everything Is Going Wrong
It’s worth putting 2022 in context. The pandemic clearly is a factor in results so far this year. Consumer spending has pivoted from buying goods in 2020-2021 to buying travel and services in 2022. Ranpak management has been firm after both Q1 and Q2 (particularly after Q2) in emphasizing that customers aren’t moving to competitors, or to plastic alternatives. Rather, there simply aren’t the volumes moving through factories, which in turn means there aren’t the volumes going through Ranpak machines. Comparisons in the first half were particularly challenging as well.
But this isn’t just a case of customers being over-inventoried amid changing end consumer behavior. An ERP (enterprise resource planning) implementation in Q1 led to delayed price increases and potentially some lost revenue, with modest effects lingering into Q2. Kraft paper prices have soared, and though Ranpak has taken some pricing, it’s chosen to sacrifice some margin as well given the struggles of its own customers. Input costs hit gross margins by 810 basis points in Q2, per the earnings call, with greater inflation outside the U.S. even excluding currency.
Of course, outside the U.S. inflation isn’t the biggest problem. It’s the economy. The energy crisis in Europe is exacerbating pandemic effects, and pressuring margins. Chief executive officer Omar Asali said on the Q2 call that “frankly, a big part of our cautious outlook and guidance, is being driven by a number of things we’re seeing out of Europe.” Again, given that the Continent accounted for half of revenue last year, that’s no surprise.
Taking The Long View
It’s worth taking a step back, however, and understanding that this is an unprecedented environment for Ranpack. Literally. Asali said (going back even to when the company was private) it had never seen the increases in input costs borne over the past 18 months.
Nothing is working in Ranpak’s favor right now. Comparisons are difficult, consumer demand has been pulled forward, Europe is in trouble, and input costs are soaring. These negative trends shouldn’t be all occurring at the same time; most notably, higher costs and macro problems should be close to mutually exclusive. (Indeed, as Ranpak noted at the time the SPAC merger was announced, despite lower revenue, Adjusted EBITDA actually increased year-over-year in 2009, in part due to lower kraft prices.)
From that understanding, two points flow. The first is that the long-term case isn’t broken by these largely short-term factors. The demand for non-plastic options from both consumers and, more importantly, governments isn’t going anywhere.
The plunge in e-commerce stocks in 2022 isn’t being driven by a reduction in the long-term outlook for the category. Rather, it’s a realization that 2021 did not, as hoped, represent a new base for growth.
Sustainable packaging for e-commerce (one-third of 2021 revenue) is still a growth market. The stronger dollar and higher kraft costs both may persist, but Ranpak (and its customers) can adapt. European economic weakness is a worry, certainly, but it’s not as if the Continent was booming in the first two decades of this century, during which time Renpak roughly tripled its sales.
The second is that, in the context of an absolutely terrible year, PACK stock is not terribly expensive. 9.5x EBITDAis not an outlandish multiple; PACK stock closed 2019 at a slightly higher valuation (based on full-year 2019 results). The news gets a bit tougher looking to free cash flow, as cash interest (~$20 million) and capex (~$50 million) will eat up pretty much all of this year’s EBITDA. But capex is a bit elevated at the moment owing to technology investments, and it only takes a return to $100 million or so to get P/FCF here relatively reasonable. Ranpak guided for $91 million to $96 million in 2020, before the impact of the pandemic became clear.
And, before the impact of the pandemic became clear, PACK was trading just shy of $8. As far as we know, nothing has really changed. E-commerce growth has continued and sustainability demands have grown. Profit margins admittedly have weakened markedly, but there are levers to pull on that front, and simply catching up to price/cost will provide a boost.
This is still a business with strong tailwinds and mid-20s EBITDA margins as is. It’s not that difficult to model a double. A low double-digit multiple (the SPAC transaction went off at 12x+ 2017 EBITDA, and that was not the same SPAC market we saw in 2020 and 2021) to $110 million in EBITDA should do the trick. That same model suggests a low 20s multiple to free cash flow, which too isn’t unreasonable if and when some degree of normalcy returns.
That rough model highlights the broad bull case here: this, too, will pass. Management will adapt, comparisons will ease, consumer behaviors will normalize. At that point, Ranpak should be able to get back to its past growth trend — with a potential upfront boost off a period of what appear to be record-low EBITDA margins. Even back in 2017 and 2018, Ranpak was able to drive $20 million-plus in free cash flow; the current price suggests a 20x multiple to that performance, hardly a high bar to clear in a more normalized environment.
Put simply, $40-plus in 2021 was the wrong price, but that doesn’t mean $5 is the right one.
Mind The Risks
Again, there are risks here, and it’s possible a mid-term double isn’t quite the reward required for those risks. A lower price would help on that front, and the short-term risk is that a lower price indeed arrives. Friday’s 6% bounce does not mean that the knife has stopped falling. We’ve been loud and consistent in our belief that there’s another leg down coming for the broad market, and PACK likely would outpace broader declines in that scenario.
But it’s possible we’re wrong on that front or that readers believe we’re wrong. It’s also possible that PACK fills the gap, particularly if this recent rally continues (as it may well do, particularly with the Fed hike in the rearview mirror).
External factors aside, the key risk here is that management is wrong in saying that the competitive environment hasn’t changed. That does seem unlikely. There’s not a ton of benefit in switching from Ranpak’s paper-based products to plastics, given higher oil prices have raised prices on that side of the business as well. The strong dollar ostensibly would open the door to a competitor in Europe, but volatile and high energy prices would undercut that advantage.
All told, it seems like at some point, the storm will pass and PACK stock will get back to being what it was in the past. What makes the stock intriguing at $5 is that “the past” only needs to be 2018, not 2021.
As of this writing, Vince Martin has no positions in any securities mentioned.
Tickers mentioned: PACK 0.00
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Ranpak’s reported Adjusted EBITDA technically does exclude stock-based compensation, since amortization of restricted stock units is not included in the GAAP EBITDA figure. But the 2023 and 2024 units require the company to hit $135 million in EBITDA, performance that seems exceptionally unlikely.
It’s possible the board reprices those RSUs, but otherwise if those shares are issued, shareholders probably won’t mind too much, since PACK stock at least doubles in that scenario.