A Bond Investor's Dream

Jeremy Glaser: I'm Jeremy Glaser for Morningstar.com. I'm joined today by analyst Dan Rohr to take a look at Sealed Air's credit and see if it's attractive for bond investors.

Dan, thanks for talking with me today.

Daniel Rohr: Thanks for having me, Jeremy.

Glaser: So, you were talking to me a little bit earlier about how you think that Sealed Air is a bond investor's dream. Why is that?

Rohr: Yeah, from a business perspective Sealed Air is, as you said, the kind of company bond investors can really love. It's boring, sure, but consistently profitable. The company's core business is food packaging, which accounts for about 65% of sales and profits. I am talking about the kind of flexible packaging that you might see covering fresh beef or chicken in the grocery store.

Now, importantly and this is more of a structural issue, Sealed Air has kind of a, I guess, you'd normally call a razor/razor blade business model that tends to keep its customer relationships rather sticky. So, while they generate a profit on the packaging equipment that they sell to these grocery stores or whoever, the real gravy is made from the consumables--demand for which tends to be only modestly cyclical since our demand for chicken, beef, what have you, tends not to vary all that much when we go into recession.

Glaser: So, how they perform during the downturn? Does their balance sheet look pretty strong then?

Rohr: Well, the operating business has performed fairly well, but the balance sheet has a couple of warts, which is why it's interesting to us. So, for 2010 we expect adjusted debt-to-EBITDA to be about 3.5 times give or take, which is kind of high for a BBB credit, which is what have the company rated.

Now notably that leverage I am talking about includes adjusted debt. So, in addition to the $1.6 billion in straight debt that they've got on the books, that includes an additional, say, $750 million in asbestos liabilities and about $100 million in pension underfundings.

Glaser: So, given some of these issues why are we rating that as an investment grade credit?

Rohr:  That's an excellent question. First of all, we expect that adjusted leverage of 3.5 times will come down quite a bit once that asbestos liability is resolved. Importantly, the company has set aside $662 million in cash along with ample revolver capacity to do just that.

Glaser: So, what's the timing of all of this?

Rohr: The liability, as far as the lawyers say, will be extinguished when W.R. Grace, the company from whom Sealed Air obtained the business with the asbestos exposure, emerges from bankruptcy. So that will trigger this payment to the asbestos trust and extinguish the liability going out, and Sealed Air management expects that to happen within the next several quarters.

Glaser: Seems like their financial picture is getting a lot better or is becoming improved. What bonds are out in the marketplace right now?

Rohr: Over the next decade, they have got a variety of bonds that are going to be maturing. So we've $400 million coming due in 2013, $300 million coming due in 2014, $400 million due in 2017.

So, which ones do we like? To your question. Those 2014 notes were offered in a private placement to Berkshire Hathaway and Davis Selected Advisers. So, unless those guys are itching to sell, we're not to going to be seeing any of those – that issue available to investors. So, the 2013s and the 2017s.

The 2013s are for a spread of around 275 basis points over Treasuries, which is a bit wider than we think they should trade. So there is some value there. But the 2017s are really what's interesting to us, since they have a very wide spread to Treasuries of about 425 basis points. And because we think Sealed Air operates with a sustainable competitive advantage--or economic moat, in Morningstar terms--we feel comfortable with the extra risk we are bearing in exchange for the extra yield that you are getting over the 2013s.

Glaser: Why are these bonds like so cheap then?

Rohr: We think one of the reasons why the bonds are cheaper than we think they should be is that asbestos cloud hanging over the companies. But with W.R. Grace likely to emerge from bankruptcy in the coming quarters, we think bondholders are likely to benefit from a near-term catalyst for spread contraction. For longer-term minded investors, you are getting bonds from a company with a boring yet consistently profitable business.

Glaser: Sounds great Dan. Thanks for talking with me today.

Rohr: Thanks, Jeremy.

Glaser: For Morningstar.com, I am Jeremy Glaser.