Richards Packaging Income Fund (TSX:RPI.UN, Financial) (RPKIF, Financial) came to my attention when I was searching for high-quality companies selling near five-year lows.

The packaging manufacturer and supplier is based in Canada, but also does business in the U.S. Established in 1912, the company has evolved from its original focus on food and beverage packaging to now having health care supplies and equipment comprise half of its business. The company serves a diverse customer base of over 17,000 customers, with 65% in Canada and 35% in the U.S.

The company also holds some leading market positions as a packaging supplier for various industries. For example, it is number one in glass/plastic packaging in health care, aesthetic devices and vision devices in Canada and number three in pharmacy automation in Canada and glass/plastic in the U.S.

Revenue and income have grown at impressive compound annual rates of over 9% and around 16% over the last 10 years. It also rose sharply over the last five years during the pandemic, but has suffered weakness in the post-pandemic period. This has caused the stock to overcorrect, creating an opportunity.

TSX:RPI.UN Data by GuruFocus

Recent results

In 2023, Richards Packaging faced challenges in its food and beverage segment, experiencing a $31 million revenue reduction, while health care revenue grew by $13 million. Cosmetic packaging saw a $3 million decrease, but rebounded in the latter half of the year. Despite these fluctuations, the company maintained a consistent Ebitda margin of 13.60%. Richards Packaging successfully reduced working capital by $33 million and achieved a leverage ratio of 0.20 times adjusted Ebitda.

Looking ahead to 2024, Richards Packaging describes it as a "year of transformation," with plans to invest in people, processes and technology to evolve its food and beverage segment and continue scaling its cosmetics and health care divisions.

Structure

Richards Packaging is structured as an income fund that owns a single business, a decision rooted in its business model and financial strategy. As an open-ended, limited purpose trust established under Ontario (Canada) law, this structure facilitated the acquisition of Richards Packaging Inc. and provides a mechanism for distributing income to unitholders on a pre-tax basis.

The primary objective is to distribute available cash to unitholders through monthly payments, a key feature of income funds. This approach offers potential tax advantages by reducing the company's taxable income through distributions. The income fund structure appeals to investors seeking regular income. Since Richards Packaging has managed to grow its earnings per share, it is attractive to those looking for steady income and potential growth.

The company's financial strategy balances income distribution with business reinvestment, helping to manage cash flow, ensure sustainable distributions and support long-term growth. Overall, the income fund structure aligns with Richards Packaging's goals of providing regular investor income, optimizing tax efficiency and supporting its long-term financial strategy.

Distributable cash flow and operating cash flow are distinct financial metrics that serve different purposes. Operating cash flow measures the cash generated from a company's core business operations, calculated by adjusting net income for non-cash items and changes in working capital. In contrast, distributable cash flow focuses on the cash available for distribution to investors, particularly relevant in income-oriented structures like income funds or master limited partnerships.

The calculation of distributable cash flow typically starts with operating cash flow or Ebitda and then makes additional adjustments. These adjustments often include subtracting maintenance capital expenditures, accounting for interest payments, taxes, changes in working capital and non-recurring items. Unlike operating cash flow, distributable cash flow may exclude growth capital expenditures.

TSX:RPI.UN Data by GuruFocus

Operating cash flow is a standardized GAAP measure, while distributable cash flow is a non-GAAP measure that can vary between companies. This non-standardized nature allows for more management discretion in its calculation, particularly in categorizing capital expenditures. Distributable cash flow is especially relevant for income-seeking investors and is commonly used in specific sectors like real estate investment trusts, MLPs and income funds. It provides a more focused view of the cash potentially available for dividends or distributions, making it a key metric for investors in these types of vehicles.

Richards Packaging maintains a dividend policy focused on monthly distributions to unitholders and dividend payments to exchangeable shareholders. It aims to distribute available cash to the fullest extent possible, with distributions typically declared for unitholders of record on the last business day of each month and paid on the 14th of the following month. Currently, the monthly distribution stands at 11 cents per unit, a figure that has remained stable in recent years. The company has demonstrated a solid track record of maintaining and growing distributions, with an average annual growth rate of about 7.90% over the past decade.

In addition to regular monthly payments, the company occasionally declares special dividends, such as the additional 38 cents per unit paid in March 2023 and March 2024. The dividend is well-covered by earnings, allowing for both business reinvestment and sustainable distributions. While Richards strives for consistency, distribution amounts may vary based on financial performance, cash flow and other operational factors. With a current dividend yield of approximately 5.50% to 5.60%, Richards Packaging's dividend policy is considered attractive for shareholder returns, though it is worth noting that future payments may be affected by compliance with credit facility covenants.

The company has been investing in growth, as shown by solid revenue and earnings figures. In spite of the generous dividend yield (5.50%), Richards retains plenty of profits for growth projects and acquisitions. Retained earnings (which is income not paid out as dividends or distributions) have compounded at a rate of 19% annually over the last 10 years. Retained earnings are reinvested in the business.

The company's ownership structure includes approximately 23% of units held by directors and management, with the majority of that held by Director Gerald Glynn and his family. Mawer Investment Management (a higly regarded Canadian investment firm tracked by Gurufocus) owns 12.30% of the company. This high level of insider ownership is an advantage as it aligns the interests of the majority with management.

Capital allocation looks solid with return on invested capital consistently above weighted average cost of capital over the past decade.

With a price-earnings ratio of around 9, Richards Packaging appears to offer a wide margin of safety. As mentioned previously, the company has grown earnings at around a 16% CAGR over the last decade. Even if we assume the next decade would only be half as good, the GuruFocus discounted cash flow calculator indicates a wide margin of safety.

Conclusion

Richards Packaging is a solid, high-quality income stock that has shown good growth in the past. The rapid growth during the pandemic and subsequent bust has knocked down the stock.

However, with the share price now much below the level it was in 2019, I think investors have a great opportunity to look past the current "reset year" and take a position in this proven compounder.