Vidrala: Glass half full

Glass demand is soft; Vidrala and Verallia are running at ~80% of capacity but there is more than meets the eye

Please note that this letter is not investment advice and I may or may not own shares of Vidrala (but I definitely do).

Both Vidrala and Verallia have reported what at first glance seem very good 9M23 results with Vidrala doubling EBITDA and more than doubling NP confirming its capacity to pass through cost inflation to clients. Both companies reiterated previous guidance, and yet, the market reaction was underwhelming, to say the least. After recent corrections, Vidrala now trades at ~10x FY23 earnings (the lowest since the PIGS sovereign crisis of 2011) and Verallia at single digits. How come?

In my previous post, I wrote that there were some concerns that might explain the current valuation:

Industry volumes are all but certain to decline in 2023 (they were already 6% down in 2Q23) as clients work through their high level of inventory built as a buffer to supply-chain issues during the pandemic and there is the ever-looming recession on the horizon. VID guided for flat volumes in 2023 but acknowledged that they might decline, but if it does, VID is still confident in its EPS guidance.

Well… Volumes are indeed declining… quite a bit more than expected. This is mainly due to both lower consumption and destocking down the value chain that caught the players off guard. So, what’s happening to this industry that is supposed to be quite predictable?

I think Verallia’s CEO Patrice Lucas puts it best:

COVID has disturbed everything. And we have seen in '20, the market slightly going down, but not so much. It was down below minus 2%. And then post-COVID, we have seen a (…) strong recovery [which] could not seem as a regular growth. (…) On top of that, there is obviously something which is related with the shortage of glass, which was taking place last year and everybody trying to secure supply (…) [as] there could be a problem with business continuity. [Furthermore] some of customers increased stocks at the end of last year before moving to '23 and with some additional price increases. (…) And then we have the '23 market, which is slowing down, and especially with the summer, which was not at the expected level.

(Verallia’s conference call, October 20th)

It seems like the reason is 2 fold: customers have built a lot of stock due to business continuity concerns and in anticipation of further price increases and now that consumption is moderating the industry is suffering a whiplash effect. Vidrala volumes declined 6% in the 9M23 and a whopping 10% in the 3Q alone.

Losing volumes but making up in price. So far, the industry has been incredibly disciplined with closures of capacity (Vidrala and Verallia) and delays in opening new capacity (Vetropack). That has allowed for prices to hold up at substantially higher than 2022’s. Vidrala’s prices are up 24% in the 9M23.

Here are some of the ways Verralia is managing capacity:

We are anticipating some maintenance with cold-stop, and we will restart accordingly with the demand, when we will see the demand back.

We have some furnace which is running with 4 lines. We are stopping 1 line, and so 3 will run out of 4, and we will reduce the pool of the glass from the furnace.

(Verallia’s conference call, October 20th)

All the reasons for the current low valuation seem conjuntural and not structural. This too shall pass and I think that in a few years, nobody will care much about the few quarters that the glass demand was soft. It’s when the outlook is clouded that one can purchase a quality company such as Vidrala at ~10x earnings. As Buffett puts it, “The stock market is a device for transferring money from the impatient to the patient.”.

For the readers that, such as myself, appreciate reading the main takeaways from earnings calls, please find enclosed my notes from Vidrala. Let me know in the comments if this is something that you would like to see posted more often:

Notes from Vidrala’s 3Q23 conference call

We are an example of a particularly protected glass player if we are to see a weaker than expected demand. - CFO Raul Gomez

• Guidance for 2024

  • Positive volume contribution expected. The CFO thinks it is unlikely that 2024 demand will be worse than 2023 as destocking will eventually end. Macro is the big question mark.

  • Sales in 2024 should reflect real demand characteristics

  • Sales might decline by -5 to -10% due to price adjusting formulas (40% of sales contracts with formulas that adjust for the price of energy), but if that is the case, margins will be kept if demands recover a little

  • Energy hedging at 60% for the next 12M, 50% in 2024 at similar levels to current market levels or slightly below. 85% hedged for 4Q23

  • Lower capex

• Volumes/prices 

  • 9M: -6% (inc The Park contribution of +2%). Prices +24%

  • 3Q: -10% (inc The Park contribution of +2%). Prices +19%

  • Performing slightly better in the UK. The integration of The Park gives more visibility in the volumes which is important in the current demand context

  • Volume declines generalised across segments: worse performance in beer, food, olive oil and spirits.

• Current utilisation today at 80%, not optimal, and to affect profitability in the next 3-4M.

• VID is an example of a particularly protected glass player if we are to see a weaker than expected demand. VID should be slightly better than peers due to the captured volumes from filling operations in the UK. Vidrala has the same capacity as 5Y ago but is now much more efficient

• Industry remained disciplined with closures of capacity (Verallia) and delays on opening new capacity (Vetropack)

• M&A

  • Weak demand helps M&A efforts to be more effective

  • Vidroporto acquisition expected to close by YE