alvarez/E+ via Getty Images

alvarez/E+ via Getty Images

Pactiv Evergreen (NASDAQ:PTVE ), the leading North American manufacturer and distributor of foodservice, food merchandising products, and fresh beverage cartons, recently agreed to sell its carton packaging and filling machinery business (Evergreen Asia) to SIG Combibloc (OTCPK:SCBGF) for an enterprise value of c. $335 million. The deal comes at an attractive implied valuation and reduces the complexity in the Beverage Merchandising segment; thus, the disposal should help focus PTVE on converting and improving its earnings stability going forward. While shares have suffered from several guidance cuts in recent quarters, I see a clear path for the shares to break out from here amid an upswing in prices across key commodity markets and an increasingly attractive EV/EBITDA valuation.

In line with the continued strategic and operational review of its Beverage Merchandising business, PTVE has announced it will divest its carton packaging and filling machinery business in Asia to a subsidiary of SIG Combibloc for $335 million. For context, Evergreen Asia produces cartons, closures, filling machines, and after-sales service to fresh beverage customers (mainly in milk) and has production facilities across China, South Korea, and Taiwan. Half of the revenue is currently generated from China, where Evergreen Asia is the leading supplier, following a solid c. 8% annualized volume growth over the course of a decade. In addition, the deal also includes a provision for SIG to purchase coated carton board from Pactiv Evergreen going forward. As PTVE and SIG were previously under the Rank Group umbrella, I see limited hurdles to the targeted mid-2022 close.

I view this sale as a positive for PTVE – not only does the valuation make sense, but the sale also frees up balance sheet capacity and allows the company to maintain a stronger strategic focus on its domestic operations. The move is also consistent with PTVE's ongoing strategic review of its Beverage Merchandising business, which has struggled post-IPO, and represents a clear signal of intent from new CEO Michael King. Since the management reshuffle (note CEO Michael King only took the position in March 2021, while COO Douglas Owenby and President of Beverage Merchandising Byron Racki joined in August 2021), PVTE's portfolio moves have been encouraging, with the acquisition of Fabri-Kal, the rationalizing of the coated groundwood business and the Evergreen Asia divestment helping to streamline the Beverage Merchandising segment.

From a financial perspective, the Evergreen Asia business' revenue of c. $160 million and EBITDA of c. $28 million (17.5% margins) equates to an EV/EBITDA transaction multiple of c. 12x - well above the c. 7x forward multiple PTVE shares currently trade at. I think the key financial implication lies in the deleveraging - while the recent Fabri-Kal acquisition was a step in the right direction, adding synergy opportunities and carving a path towards a higher sustainable solutions contribution, it also moved the net leverage to over 6x. Assuming PTVE realizes gross proceeds of $335 million, the sale would immediately drive this 0.3x lower, with pro-forma leverage on track to hit sub-4.5x at end-2022.

Looking ahead, PTVE looks set to benefit from a continued volume recovery, although volumes may not match demand in light of ongoing labor constraints at the company's converting facilities. Per management, there is currently a 1.5k employee shortage (equivalent to c. 10% of its labor workforce) at its converting plants, which could dampen volume growth throughout early-2022. With the company's volumes likely to remain below pre-pandemic levels by year-end as a result, this presents continued medium to longer-term upside as volumes eventually come back. Additionally, I see the volume recovery driving strong incremental margins following the implementation of the recent strategic investment program, supporting incremental upside ahead. Meanwhile, the price decline of polypropylene and polyethylene below their highs should also provide some offsetting benefit to FQ1 '22 earnings given pass through typically lags by a quarter (note PTVE has c. 70% of its plastic packaging volumes tied to a lagged contractual pass-through mechanism for resin).

Beyond the post-COVID-19 earnings recovery over the next year or so, PTVE could also reap medium to longer-term benefits, having gone through a transition period in recent months. To recap, the company has already spent $542 million through FQ3 '21 (out of a total of $661 million) on its "Strategic Investment Program." With these investments targeted to have a 2-2.5-year payback and the company only realizing $179 million of benefits to date, there remain plenty of earnings upside ahead. Furthermore, the company is still in the midst of an overall leadership transition, and considering the new executives were external hires, expect some new initiatives down the line.

While the sale will likely be dilutive, I view the disposal of PTVE's packaging and filling machinery business as a strategic positive as it will accelerate the deleveraging and allow for a stronger focus on its domestic operations. Looking ahead, the setup seems compelling into the upcoming year – having been weighed down by one-time disruptions in fiscal 2021, the company looks poised to deliver substantial earnings improvement as volumes come back into the business post-COVID-19. And with the strategic and operational review (with the aid of a third-party) still ongoing, there remain plenty of potential upside catalysts to drive the shares higher.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.