Silgan Holdings Inc Q4 FY2020 Earnings Call

Thank you for joining the Silgan Holdings Fourth Quarter and Full Year 2020 Earnings Results Conference Call. Today's call is being recorded. At this time, I would like to turn the call over to Kim Ulmer, Vice President, Finance and Treasurer. Please go ahead.

Thank you. Joining me from the company today, I have Tony Allott, Chairman and CEO; Adam Greenlee, President and COO; and Bob Lewis, EVP and CFO. Before we begin the call today, we would like to make it clear that certain statements made today on this conference call may be forward-looking statements. These forward-looking statements are made based upon management's expectations and beliefs concerning future events impacting the company, and therefore involve a number of uncertainties and risks, including but not limited to those described in the company's Annual Report on Form 10-K for 2019 and other filings with the SEC. Therefore, the actual results of operations or financial condition of the company could differ materially from those expressed or implied in the forward-looking statements. With that, I'll turn it over to Tony.

Thank you, Kim. Welcome everyone to Silgan's 2020 year-end conference call. With 2020 in our rear view, and with high hopes of putting the challenges of 2020 behind us, I want to thank the entire Silgan team, point out a few of the 2020 highlights and provide a brief preview of our 2021 outlook. Bob will then review the financial performance for the full year and fourth quarter and provide more detail around the 2020 outlook. Afterwards, as usual, Bob, Adam and I would be pleased to take any questions that you have. Let me start by expressing our gratitude and deep respect for the entire Silgan team who rose to the challenges during these unprecedented times to meet the expanding needs of our customers supplying essential products to our vulnerable communities. Throughout this pandemic, our employees have repeatedly demonstrated their strength, commitment, and the power of our performance-based culture as they did everything possible to ensure we met these unprecedented demands. As a result, we were able to achieve several milestones in 2020 and are well positioned for further growth in 2021. As covered in our press release, 2020 was an exceptional year for the company. Some of the highlights included: we achieved record financial performance across the board including revenue, which increased to $4.9 billion, with strong volumes experienced throughout the year. Adjusted net income per diluted share of $3.06 was up 42% versus the prior year. Free cash flow of $383.5 million, or $3.44 per diluted share, were at record levels. We attained our target leverage ratio just seven months post the recent acquisition, positioning the company to take advantage of future cash deployment opportunities. And we increased our cash dividends for the 16th consecutive year. While achieving these performance metrics, we also invested in several important growth initiatives, including completing the acquisition and integration of the dispensing operations of Albéa Group, initiating commercial supply for a major pet food customer expansion in Eastern Europe, managing several significant new business wins in the plastic container business which are expected to generate further growth in 2021 and beyond, initiating several capacity expansion projects for dispensing triggers and pumps to support significant customer growth anticipated in health and hygiene product offerings, and meeting customers' increased need for local production. Simply put, our business franchises have never been stronger, our employees never more resolute, and our confidence in the future never more resolved. Therefore, as Bob will discuss in more detail, we're providing full year guidance for adjusted earnings per diluted share in the range of $3.30 to $3.45. The midpoint of this range represents a 10.3% increase over 2020. We also expect free cash flow to again be approximately $380 million. With that, I'll turn it over to Bob.

Thank you, Tony. Good morning, everyone. As Tony highlighted, volumes remained strong throughout 2020 as we benefited from more at-home consumption, a trend of more stringent personal hygiene habits, and several strategic investments in new business, all while overcoming the challenges of keeping our workforce safe and integrating a newly acquired business. As a result in 2020, we delivered adjusted earnings per diluted share of $3.06. And we delivered free cash flow of $383.5 million, significantly better than the prior year of $271.7 million. On a consolidated basis, net sales for the year were $4.92 billion, an increase of $432 million or 9.6% over the prior year. This increase was the result of higher net sales across each of our businesses. We converted these sales to net income for the year of $308.7 million or $2.77 per diluted share, as compared to 2019 net income of $193.8 million or $1.74 per diluted share. In 2020, adjusted earnings per diluted share included adjustments that increased earnings per diluted share by $0.29 for rationalization charges, costs attributable to announced acquisitions, the purchase accounting write-up of inventory and the loss on early extinguishment of debt. In 2019, adjusted earnings per diluted share included adjustments that increased earnings per diluted share by $0.42 for restructuring charges, costs attributable to announced acquisitions and a loss on early extinguishment of debt. As a result, adjusted net income per diluted share was $3.06 in 2020, up 42% versus $2.16 in the prior year. Interest expense before loss on early extinguishment of debt decreased $1.9 million to $103.8 million, primarily due to the lower weighted average interest rates, partially offset by higher average outstanding borrowings, primarily related to the recent acquisitions and additional revolving loans outstanding in the early part of 2020, as we held cash to guard against potential credit market disruptions in the early days of the COVID-19 pandemic. In addition, we incurred a loss on early extinguishment of debt of $1.5 million and $1.7 million in 2020 and 2019, respectively. Our effective tax rate was 24.2% and 23.1% in 2020 and 2019 respectively. The effective rate for 2019 was favorably impacted by the resolution of a prior year tax audit and the timing of certain tax deductions. Full year capital expenditures totaled $224.2 million in 2020 versus $230.1 million in 2019. Additionally, we paid a quarterly dividend of $0.12 per share in December. The total cash cost of the dividend was $13.2 million. For the full year, we've returned $53.6 million to shareholders in the form of dividends. And in addition, during the year we repurchased stock in the amount of $35.9 million. I'll now provide some specifics regarding the individual financial performance of each of our businesses. The Metal Containers business recorded net sales of $2.56 billion, up $84.8 million versus the prior year. The increase was primarily due to higher unit volumes of approximately 14% and favorable foreign currency translation of approximately $4 million, partially offset by the pass-through of lower raw material costs, a continued shift towards smaller metal packages sold and the impact from the renewal of certain significant customer contracts at the end of 2019. The increase in unit volumes was principally due to higher demand in at-home consumption. Segment income in the metal container business was $246.6 million, an increase of $86.6 million versus the prior year. This increase was primarily attributable to higher unit volumes, $39.5 million of lower rationalization charges, strong operating performance, and higher pension income. These increases were partially offset by the impact from the renewal of certain significant customer contracts at the end of 2019, and a shift toward smaller metal packages sold. Rationalization charges totaled $9.9 million and $49.4 million in 2020 and 2019 respectively. The 2019 rationalization charges were largely a result of the shutdown of two manufacturing facilities and the withdrawal from the Central States pension plan. Net sales in the closures business were $1.71 billion in 2020, an increase of $306.8 million versus the prior year. The increase was primarily the result of higher unit volumes of approximately 8% and a more favorable mix of products sold, partially offset by the pass-through of lower raw material costs and unfavorable foreign currency translation of approximately $4 million. Unit volumes increased principally as a result of the inclusion of the two recent acquisitions, and increased demand for consumer hygiene, health, personal care, and food and beverage products. These volume gains were partially offset by weaker demand for certain beauty and fragrance products. Segment income in the closures business for 2020 improved $50.9 million to $224.4 million, primarily due to higher unit volumes, including from acquisitions completed in 2020, a more favorable mix of products sold, strong operating performance and higher pension income, partially offset by the negative impact of a $3.5 million charge for the purchase accounting write-up of inventory as a result of the acquisitions completed during the year. Net sales in the plastic containers business increased $40.4 million to $651.5 million in 2020, principally due to higher volumes of approximately 11% partially offset by the pass-through of lower raw material costs, a less favorable mix of products sold and unfavorable foreign currency translation of approximately $1 million. Segment income increased $38.9 million to $87.8 million for the year largely attributable to higher volumes, strong operating performance, lower manufacturing costs and higher pension income, partially offset by the unfavorable impact of a $3.2 million charge for a non-commercial legal dispute relating to prior periods and the unfavorable impact from the lagged pass-through to customers of higher resin costs. As we look at the fourth quarter, we reported earnings per diluted share of $0.54 as compared to $0.31 in the prior year. Earnings per diluted share was increased by $0.06 in 2020 and by $0.07 in 2019, resulting in adjusted earnings per diluted share of $0.60 in the fourth quarter of 2020 versus $0.38 in the same period a year ago. Net sales for the quarter were $1.23 billion, up $178.3 million versus the prior year driven primarily by higher volumes in each of the businesses, a more favorable mix of products sold in closures and favorable foreign currency translation of approximately $10 million. These increases were partly offset by the pass-through of lower raw material costs, and a continued shift towards smaller metal packages sold in the metal containers business. The increases in volumes were principally due to the inclusion of the acquired businesses and continued high demand for food, consumer health, hygiene and personal care products. Income before interest and income taxes for the fourth quarter of 2020 increased by $33.6 million to $105 million, primarily due to higher volumes and strong operating performance across all businesses, higher pension income, a more favorable mix of products sold in the closures and plastic businesses and higher costs in 2019 attributable to announced acquisitions. These gains were partially offset by a continued shift towards smaller metal packages sold in the metal container business, the impact from the renewal of certain customer contracts at the end of 2019, the unfavorable impacts from the lagged pass-through to customers of higher resin costs in the plastic container and closures businesses and higher rationalization charges in 2019. Interest expense for the fourth quarter of 2020 increased $3.4 million to $26.8 million as a result of higher average outstanding borrowings, largely due to the acquisitions completed in June, partially offset by lower weighted average interest rates. The effective tax rate for the fourth quarter of 2020 was 23.2% as compared to 27.5% in 2019. Turning now to our outlook for 2021. Our estimate of adjusted earnings per diluted share for 2021 is in the range of $3.30 to $3.45. The midpoint representing a 10.3% increase over record adjusted earnings per share of $3.06 for the full year of 2020. Reflected in our estimate for 2021 are the following. Segment income in the metal container business is forecast to benefit from anticipated higher volumes, continued manufacturing improvement and higher pension income. The closures business is expected to benefit from anticipated higher volumes including the full-year benefits from the acquisition, some back-half recovery in the beauty and fragrance markets and new business gains as well as improved manufacturing efficiencies and higher pension income. We're expecting the plastic container business to benefit from anticipated volume gains, manufacturing efficiencies, and higher pension income. In addition, we expect interest expense to increase versus 2020 largely as a result of higher average outstanding borrowings as a result of the June 2020 acquisition, partially offset by lower average interest rates. We currently expect our tax rate to be approximately 25% as compared to the effective rate of 24.2% in 2020. This estimate does not contemplate the effect of any tax law changes that may arise during the year. Also we expect capital expenditures in 2021 to be approximately $230 million, up slightly from 2020 as we have a full year of the dispensing business acquired from Albéa, and we fund certain customer growth projects. We're also providing our first quarter 2021 estimate of adjusted earnings in the range of $0.65 to $0.75 per diluted share. The midpoint of this range represents a 23% increase over $0.57 in the first quarter of 2020. These estimates exclude rationalization charges, costs attributable to announced acquisitions and losses on early extinguishment of debt. Based on our current outlook for 2021, we expect free cash flow to be pretty stable, and are providing an estimate of approximately $380 million as earnings growth is largely offset by slightly higher CapEx, and less cash generated from working capital. That concludes our prepared comments. Before I turn it over, I'd like to remind everyone to limit their time to one question and one follow-up. As time permits, we'll take additional questions from the queue. With that, I'll now turn it over to Madison to provide directions for the Q&A session.

Operator provided instructions for submitting questions. Our first question comes from Adam Josephson with KeyBank.

Thanks. Good morning, everyone and congrats on another very good quarter. Bob, it may sound strange to ask about pension first. But if memory serves you were thinking that pension would be a $10 million to $15 million drag in 2021 on your last call, and now you're expecting higher pension income in 2021. So can you just talk about how much of a swing and the expectations you've had from the last call and what drove that?

Yes, well, it's all directly related to what happened in the equity markets or in the markets broadly in the final throes of the year. So at the time of our last call, the market was not performing very well and returns on the portfolio of pension assets were not great. We've seen a really nice recovery, and that has swung us, despite some degradation in the discount rate which, quite frankly, hurts us. The net of that is we saw it move from what we expected to be a pension headwind of about $10 million or so to being a pension benefit in the neighborhood of $10 million.

Got it. That helps. And then can you be any more specific about your volume expectations in 2021? I believe you said you expect your food can volume to be up even on the exceptionally difficult comp. I know you said you expect plastics volumes to be up. Closures, I didn't catch what your organic volume expectations were for closures for 2021? Can you just provide as much detail as you can about what rate of volume growth organically you're expecting in 2021? And why?

Sure. Hey, Adam, it's Adam, and thanks for the comments and the question. Maybe just starting with our metal food can business for 2021. We talked a lot on the last call about the run rate of the business and the run rate of the volumes we were experiencing. As we head into the year, we were essentially running at full capacity in Q2, Q3 and Q4. The pandemic didn't really impact our metal food can business until very late in Q1 and certainly in Q2. So we talked about the shoulders of the year — that's where our capacity exists. And that's absolutely the case as we look at 2021. The good news is we came out of the year with great momentum in Q4 with our second-highest unit volume quarter of the year, and our orders are fully loaded for Q1. So we know as we sit here today that our Q1 volume is going to look a lot like our Q4 volume; mix might shift a little bit, but the absolute volume is going to be up pretty significantly versus 2020. And then that'll carry over the course of the year. We do have a tough comp in Q2, as a reminder, because some of that pandemic buying did occur in the early part of Q2; we were able to liquidate quite a bit of our inventory. So while we were running and selling, we also sold out inventory, and then moved into Q3 in the metal can business. We talked a lot about the pack; the pack was not really able to respond in a large way, or customers weren't able to respond in a large way, to the increased demands of the pandemic. So while we don't have final numbers yet for pack volumes, we do know and we work with our customers very closely on this, we know that they are planning a sizable increase to their pack volumes in the U.S. We know they're going to contract additional acreage in the U.S. and they're expecting a really good pack for the year. I think those items all together are what gives us a lot of confidence in our metal container business that we'll see continued strength over the course of the year. On closures: first, we have the acquisitions in 2020; we have seven months of those. We will have a full 12 months in 2021. When we talk about the fragrance business specifically with Albéa, we're expecting a recovery of something like half of the detriment that we experienced in 2020. On our last call we said we were seeing some positive signs but didn't want to get too far in front of ourselves. We were down in the fragrance business call it 30-ish percent in Q2 and Q3, and we did start to see improvement in Q4, so our orders are a little bit stronger in Q1 as well. We feel really good about the Albéa business and the fit with Silgan. On our legacy dispensing systems business, we saw another 15% growth in Q4 excluding Albéa. The business continues performing at an exceptionally high level, consistent through the back half of 2020, and we're expecting that to be consistent through 2021 as well. One other item in our closures business was our hot-fill plastic closures for sports drinks and ready-to-drink teas; we did see nice growth in 2020, up high single digits in that business, and that's going to continue next year, maybe not quite at the same rate but we're expecting kind of our traditional growth rate for our hot-fill plastic segment. For plastics: we continue to execute and win in the markets we're serving in our plastics business. Our performance has been exceptional. We're being rewarded with new business when our team has done a great job of meeting those unique needs of our customers. When you look at the annualization of the business wins commercialized in 2020 and the new wins coming on in 2021, plus additional growth in our core markets, we feel really good about our plastics business too. So very long answer, Adam, I apologize, but there's a lot to it. We feel really good about where we're going in 2021 and beyond.

Our next question comes from Mark Wilde with Bank of Montreal.

Thanks. Good morning, everyone. Tony, I had a portfolio question. You've made a number of moves, particularly to expand closures and dispensers in recent years, and this has shrunk the amount of your business in metal food cans. Just help us understand how you would think about potentially toggling the portfolio back toward food cans over time.

Sure, Mark. So first of all, what you said is true. We certainly have invested a lot in the last couple of years in the dispensing systems side of our business, particularly in closures. In fact, if you look this year, the metric we watched the most is EBITDA by business. Essentially, the closures business was the same EBITDA as our can business this year. Based on everything Adam just took you through, our expectation right now is that closures will be a bigger business than food cans for us next year. That might lead you to think that means we're moving away from food cans. That's not the case. What we've been doing for a long time is taking high cash generation and deploying it in areas where we think we get really good high cash returns for our shareholders. That has happened to be more in the dispensing area, and we're glad it has been. It's been great. But as we look at the portfolio, we really never feel like we've been in a spot where all of our franchises are as strong as they are right now. Plastic has done a wonderful job of showing itself to the market in a trying time and they are being rewarded, as Adam just said, with contracts. The dispensing systems business already was known to be a premier supplier of that market and they proved it again, and so they are being rewarded. We are making investments there to expand capacity to meet this increased demand. So we see a lot of growth opportunities on both of those sides, which are the bigger part of what Silgan is today. That said, we also have always liked food cans. We know the market struggles with organic growth in food cans. We don't, and taking what's happened last year into account, it's been strong cash flow and good opportunity. Given our share in the markets we are in, acquisitions have been a little bit tougher to find, but it's been a great business for us in terms of generating cash and opportunities going forward. That's how we think about it going forward. Any one of those areas in rigid packaging can be a high cash return in our portfolio for future investments.

Okay. If I can just follow on the can business. Is it possible for you to continue to grow revenues and earnings in food despite the shift toward smaller and lower-price cans over time?

Absolutely. In fact, that's what we've been talking about for a couple years: we expected a growth curve for our can business because the markets we're in in a substantial way have been growing. For example, pet food and protein have become a much bigger part of our overall can portfolio and they've been growing steadily. So we never thought we'd see a change in direction of growth, we just knew the mix of our portfolio was shifting toward growth can markets. We view there to be growth opportunity in our can business. Secondly, coming back to COVID, historically our expectations were for the mix shift; now we've had COVID. It's not just pantry-stuffing; more consumers are using cans now who hadn't before, they're being exposed to them and realizing the benefits, sustainability, and good quality of canned food. We're helping and our customers are helping to send that message. So on top of the mix shift toward growth markets, there's a new dynamic of people rethinking their view of canned food, and that further supports why we like food cans now as much as before.

Our next question comes from Gabe Hajde with Wells Fargo Securities.

Tony, Bob, Adam, good morning. Hope you and your families are well. I had a question on the inflation side, which is probably a little more pronounced than it was last time we spoke in October. Maybe give us a look at it from two angles: raw materials (resin and tinplate steel) and how your pass-through mechanisms work and what you're anticipating for the full year in terms of the resin side and tinplate steel. Also, how well the price-cost pass-through may shake out by segment.

Hey, Gabe. You're right. We do have very good pass-through mechanisms for the inflationary items you mentioned, particularly in the food can business. To start with steel, we are expecting kind of a high single-digit to low double-digit increase in our steel costs for the year. As a reminder, steel is a direct pass-through to our customers, so that inflation is borne by customers rather than Silgan in most contracts. Coating systems, freight and other consumables in our steel business also generally get passed through to customers, depending on contract language. For plastics and closures, which are more resin-based, we called out a slightly unfavorable resin impact in Q4, and it is expected to be an unfavorable impact in Q1 given recent resin price increases. Our resin pass-through mechanisms vary by business, but broadly they are index-based with providers such as IHS or CDI, with lags typically of 30 to 45 days, and sometimes 60 days depending on agreement. Those costs are passed through to the market, and the issue we had in Q4 and into Q1 is when there's a significant spike in resin costs, it takes time to get those costs passed through to the market.

Everything Adam said is spot on. I would add that passing through costs to customers doesn't eliminate the problem for our customers; we fight to keep inflation down because it does affect them. Adam gave you the net answer, but I wanted to emphasize that pass-through doesn't mean it's not a concern for our customers.

Thank you, Tony, Adam. On metal food, do you have any insight into customer inventories? It doesn't look like inventories are up that much, which would coincide with what you said about selling through. Does that imply production this year needs to be full to maintain and perhaps replenish inventories, especially given increased plantings? Does that imply volumes will be up in metal food in your budgeting?

Great question. As we sit here today, we are expecting a slight increase in our metal food volume year-over-year in 2021. We do not see a major supply chain replenishment of inventory right now. We spend a lot of time with customers understanding consumer behavior; our customers are also studying this. We have new consumers for food cans and we're a year into the pandemic — we don't believe those cans are sitting unused in someone's pantry. These new consumers are actually using canned food, and we've seen an increase in repurchase rates among these consumers. That gives us confidence for 2021. Also, even if inventory replenishment does occur, we'll still have to make essentially the same number of cans, because whether those cans get sold through to a consumer or replenish the supply chain, they still must be produced. So whether sales are consumed or inventory is rebuilt, the production need will be similar, especially later in 2021 or beyond.

Our next question comes from Salvatore Tiano with Seaport Global.

Hi, Tony, Adam, Bob. Congratulations on a great quarter. First, on food can volumes and what your expectations are after 2021: it seems you are saying it's not really restocking that you're seeing in Q4 or what you're expecting in 2021, so is it safe to assume that as we look past the year volumes can remain flattish and then return to a more regular level with some growth in pet food and perhaps stability or declines in other markets? Is that how we should think for 2022 and afterwards?

Great question. We're in early 2021, so it's a bit early to speak about 2022 in detail, but you have it right. At some point the supply chain does need to be replenished with inventory — our customers' inventories, retail inventory, distribution warehouses, etc. We're not expecting that to happen in 2021 in any big way. If there were a slight pullback from consumers — for example, if restaurants recover and compete more for occasions — there is still a significant amount of inventory that needs to be rebuilt in the system. I would look at 2022 as the earliest year in which replenishment would likely occur, given our current outlook.

Okay, perfect. And on capital allocation: what are your limitations with leverage, what would be your limit if you're looking at acquisitions, and can you talk about pros and cons of M&A versus buybacks, especially with the free cash flow yield of the stock around 9–10%?

Good question. There's no change in strategy here. We've long been disciplined about our balance sheet, thinking about a 2.5x to 3.5x year-end net debt-to-EBITDA leverage range. We're kind of right at the top end of that as we exit the year, having spent a lot of time and efficiently integrated acquisitions in 2020. We feel pretty good about the bandwidth of the broader organization to take on another opportunity. Our M&A strategy remains disciplined: returns matter and industrial logic matters. If opportunities that fit rigid packaging for consumer goods and meet our return hurdles present themselves, we'd be happy to take advantage. If they don't, we will be patient and perhaps delever a bit. We have not typically done large share repurchases unless we were at the lower end of our leverage range or the market was dislocated. We remain disciplined and patient; that's how we've created a lot of value over time and we do not intend to change that.

Our next question comes from Anthony Pettinaro with Citi.

Good morning. With the expectation to grow volumes over a very strong 2020, can you talk about your footprint in metal containers? Are you basically running full out, or do you need to debottleneck or add capacity in any categories given the mix shift you discussed? Also, regarding customers investing in filling lines or new brands, are you seeing signs of customers making investments that reflect increased demand for cans?

I'll start with the second question. Our customers have been focused on getting full utilization out of the assets they have to meet the unique needs of consumers. Right now it's been more focused on utilizing existing capacity. Regarding our footprint at Silgan: we announced a footprint optimization program in 2019 and put that on pause. As we sit here today, our capacity is pretty well in line with our customers' filling capacity. We are experiencing some unusual freight and supply-chain disruptions, but we've done a great job of getting cans where they need to be for customers to fill and get to the market. So we don't see an immediate need to add capacity in the short term, but we're working closely with customers to understand their forward-looking needs.

Okay, that's helpful. Adam, can you talk about the pathway to recovery for beauty in 2021? When that business first got hit, the percentage sold to North America vs Europe vs Asia, are you seeing improvement in any region, and what's the visibility into demand?

Good question. For fragrance specifically, travel restrictions put in place early in 2020 had a significant impact on our fragrance business, much of which goes through retail channels and travel retail and mall channels. That lockdown drove weakness in fragrance. The markets most impacted were Europe followed by North America. What gives us a positive view is what happened in South America, particularly Brazil — we saw a rapid recovery in fragrance there as economies reopened and travel began. We've seen progress in South America and Asia. Also, many fragrance products historically went through on-premise retail channels; we've spent time with customers to reach consumers differently, shifting to e-commerce platforms, samplers, and direct-to-consumer strategies. We've seen an uptick in the e-commerce channel for fragrance. At the height of the pandemic, fragrance volumes were down roughly 30%. We saw improvement in Q3 and further improvement in Q4, and we feel pretty good there's going to be a recovery in 2021, which we are pushing toward the back half of the year. We're expecting roughly half of the detriment we experienced in 2020 to recover in 2021.

Our next question comes from George Staphos with Bank of America.

Thanks. Hi, everyone. I want to come back to metal food. From our trade research, customers are trying to refill the pipeline but sometimes can't because of capacity constraints. Is there a way to index what your shipments might look like this year relative to consumption? Hard to quantify, but any qualitative sense of whether customers are planning increased plantings as a proxy for pipeline refill versus consumption? Also, a nitty-gritty on earnings.

George, it's nearly impossible to answer precisely, but qualitatively our customers would like to rebuild inventories because they've been running lean and inefficiently. We are not assuming they will be able to fully rebuild in 2021; our expectation is the market pull will be strong enough that there won't be significant refill in 2021. Adam mentioned that plantings and contracts for acreage are up in certain markets, such as fruit and vegetable, indicating plans to pack more, whether to restock or to sell is yet to be determined. We believe there simply wasn't enough product last year and greater sales would have occurred had there been more product. Our assumption is consumption will absorb much of the available supply in 2021 and any substantial replenishment of inventories will likely occur in 2022.

If I could follow up: could you quantify the effect of new volume in Europe or Eastern Europe on your overall metal food volume outlook for 2021? Also, on inventory, sequentially inventories typically declined; this year they didn't. Is there anything strategic in Q4 that we should be mindful of for 2021? And what's the outlook on depreciation for 2021, recognizing FX and other items?

On the Europe piece, we prefer not to give that granular customer-level detail; it's important but it represents new production and commercial supply that is worth mentioning generally. We won't quantify specific customer volumes. Bob, on the inventory line and depreciation, I'll let you comment.

George, regarding inventory, one factor is the incremental inventory from the Albéa business in Q4 that you didn't have in the prior year. Regarding the expectation for Q4 versus Q3, Q4 is not a very predictable quarter for inventory movements — it depends on what we're preparing for the year ahead. So it's a volatile quarter. But to your point, there's not much in the way of inventory gains we would flag for next year beyond what is already embedded in our guidance. On depreciation, we don't have a material change to signal beyond the normal cadence; any specifics will be reflected in our quarterly reporting as depreciation is recognized.

Our next question comes from Arun Viswanathan with RBC.

Great. Thanks. Good morning. First, on margin performance: given the strong sales gains in 2020, how should we think about the incremental margin in 2021, especially with pass-throughs for raw materials? How much of the temporary costs you gained in 2020 are coming back in 2021? And how might freight impact incremental margins?

There is a lot to that question. In 2020 margins benefited from a heavy increase in volume and a system that could not easily expand cost-wise, so we essentially filled capacity. We also benefited from running at full utilization while liquidating inventory, which was a unique circumstance in 2020 that we cannot replicate in 2021. We see good growth opportunities across the business and have invested for returns we view as attractive. We are not necessarily saying the absolute margin rate of 2020 is fully recurring in 2021; some rates may come down for the reasons I mentioned. But overall, we see very good returns on capital being spent.

Okay, thanks. And specifically on freight and temporary costs — have you seen increases that will affect 2021? Also on M&A, have you seen a rise in valuations and is there any situation where you'd consider getting larger in metal containers, perhaps outside North America?

Arun, on freight, availability was a challenge around the holidays and in Q4 and that has persisted into the start of the year, so freight costs are up. We fight to keep freight costs low because they are largely passed through to customers. On temporary COVID-related costs, we had COVID-related expenses in 2020 and have essentially assumed a similar level in 2021, so we expect them to be flat year-over-year. On M&A and valuations: our priority has long been disciplined acquisitions where returns and industrial logic make sense. We still see acquisitions as interesting and continue to look. Regarding metal containers, we like the can business for its free cash flow characteristics and sustainability story; however, price and returns will dictate whether we pursue specific acquisitions, and we remain focused on returns and discipline.

Our next question comes from Ghansham Panjabi with Baird.

Hey, good morning. Going back to the cost side and the inflation of raw materials, how should we think about the impact on working capital? You sold out of inventory last year and costs are rising — will that be a negative draw on working capital? Also, for some of the larger contracts within metal food, do you have to cycle through any CPI index from last year that may be deflationary relative to inflation this year?

Ghansham, yes we benefited from some liquidation of working capital in 2020, and that likely will not recur, which is a headwind year-over-year. Given some inflation in raw materials, we could see some pressure on working capital. All of that is in the context of our guidance of approximately $380 million free cash flow for 2021. Adam can comment on indexed pass-throughs.

Ghansham, on indexed pass-throughs for labor and other items, those are embedded in our numbers. If there is a disconnect between what's happening in the market and a deflationary pass-through, that's already embedded in our outlook going forward.

Got it. And on the food service side of metal food can exposure: where are we on inventories in that channel? Have you started seeing improvement as we cycle into 2021? Remind us how big food service specifically is for metal food?

Good question. Our food service business, particularly in the tomatoes market, saw a significant slowdown starting in Q2 and Q3 of 2020. We're not expecting a significant recovery in volumes until pack season, probably in Q3 of this year. You won't hear much conversation around those volumes until later in the year. As a percent of the total, it's a small percent of our business, but these are valuable cans and thus have a mix impact on the revenue line.

Our next question comes from Kyle White with Deutsche Bank.

Hey, good morning. Hope everyone's well. Regarding Albéa and beauty/fragrance, do you need a recovery in duty-free retail to drive meaningful improvement in volumes, or can you get recovery from other retail channels like digital? What are the implications of higher e-commerce for mix and margins?

Good question. We don't need a retail or travel recovery to achieve what we're planning for 2021 in fragrance. E-commerce efforts may actually benefit Silgan. For example, sampler packages customers are sending out are smaller dispensing systems than full bottles, but multiple samplers may yield a full bottle purchase. Early traction suggests e-commerce could increase overall volumes in fragrance. We're early on this trend but we don't need full travel or retail recovery to meet our fragrance expectations for 2021.

Got it. On the guidance expansion, you widened the typical EPS range by about $0.05. Is that due to pandemic uncertainty? And as closures and plastics become a larger portion of the business, does that mean less predictability compared to the food can business?

Yes, it's primarily due to the many moving parts and uncertainty as we come off a pandemic. There's a lot unknown, so a slightly wider guidance range made sense.

Our next question comes from Jeff Zekauskas with JPMorgan.

Thanks. Are the terms of trade with your food can customers improving given the increasing tightness in the market and the strength of your volumes?

The bulk of our food can business is under long-term contract. The historical relationship with customers is consistency and predictability; we honor our contracts. So I wouldn't expect wholesale change in terms unless new business coming up commands different terms due to capacity constraints, but short of that, no major change.

In Q3 and Q4 of 2021, can you grow your can volumes given you operated full out in Q3 and Q4 of 2020?

Q3 is typically our largest quarter from a volume standpoint because of pack-related items and was pretty fully utilized. If there's room for growth, it would be more likely in Q1 and Q4 where more available capacity historically exists.

Our next question comes from Daniel Rizzo with Jefferies.

Thank you. How should we think about rationalization costs and working capital in 2021 compared to 2020?

We benefited from liquidation of working capital in 2020 which helped free cash flow; that likely won't repeat in 2021, so that's a headwind year-over-year. Given inflation, we could see a modest detriment in working capital, but overall we're comfortable with where working capital is relative to our $380 million free cash flow guide for 2021.

On rationalization costs: we have a relentless focus on reducing costs in our manufacturing system, but given our plans for 2021 we don't have any rationalization projects we are looking to implement this year. We have the footprint optimization in the metal container pack business that we announced in 2019 on pause, and we're continuing to evaluate capacity needs versus customer requirements.

Thanks. One other question: you mentioned M&A. Is there an upper limit on debt level you'd consider for an acquisition, given your free cash flow generation?

We've long been disciplined around that 2.5x to 3.5x range. We ventured outside that range in 2017 and again in 2020 for the dispensing acquisitions, which were relatively large (around $900 million). Those took us into the low to mid 4s at the point of acquisition with a pathway back into the corridor relatively quickly. We don't have a lot of appetite to go significantly beyond that, but depending on the opportunity and returns, we would consider it.

We will take our next question again from Adam Josephson with KeyBanc.

Thanks for taking my follow-ups. Tony or Adam, can you just talk about differences between the U.S. and European food can markets in terms of growth and return profiles, given you're in both markets, albeit smaller in Europe?

Good question. Our businesses are quite different: our European business is more Eastern-focused, entrepreneurial, with smaller plants, whereas our North American business is with leading customers and more efficient systems. Margins are generally higher in the U.S. Food cans have higher penetration in Europe historically and are a more used package there, making Europe a bit steadier. The U.S. consumer historically ate more out-of-home and restaurants, so the U.S. saw a bigger change with COVID. The U.S. also has growth areas like pet food and protein which have driven our growth. So the markets differ, but both are attractive for different reasons.

On ESG, you mentioned recyclability benefits of canned food. Investors often ask about Silgan's sustainability disclosures — you don't have a sustainability report on the website. How do you think about that issue and its effect on valuation and investor perception?

Great question. I agree we've been too quiet about this. We believe our package is a strong sustainability solution, and we'll prepare a sustained ESG/sustainability report to tell that story more clearly. We believe we have a strong message once we present it properly.

Adam, one last on resin: what's your annual resin buy mix of polypropylene vs polyethylene vs PET, and what earnings drag are you expecting in Q1 from recent resin spikes?

I won't give specific purchase volumes, but our single-largest resin is polyethylene, then polypropylene, then PET, with various niche resins used across the business. The most volatile recent resins have been polypropylene followed by polyethylene. We use both polypropylene and polyethylene across our resin-based businesses. Our guidance accounts for resin inflation and the lagged pass-throughs, and Q1 will be negative due to those lag effects.

We'll take a question from Salvatore Tiano.

Two quick follow-ups. First, last quarter you talked about Albéa and said you might see zero EPS accretion this year. Can you confirm whether Albéa added or subtracted to EPS in 2020? Second, would you consider issuing stock for a larger-than-usual acquisition?

On Albéa, one of the pleasant upsides to our guidance was that Albéa was $0.02 accretive to EPS in Q4 2020. On issuing stock for acquisitions: we've never done an acquisition where we've included equity and we've generally avoided it because equity is our most expensive cost of capital. We wouldn't say never, but it would have to be a very compelling transaction for us to include equity as part of the consideration.

We'll take our next question from George Staphos.

Thanks for taking the follow-up. A compliment: plastics has done a phenomenal job improving margins and the service model. What gives you the most confidence that the new plastics Silgan is building has a durable moat around the business for long-term profitability?

Thank you, George. The plastics team has done a phenomenal job. The moat is less about unique technology and more about our service model and relentless focus on meeting customer needs — launching products right and on time, and serving customers as they bring new products to market. That customer-centric capability is now a hallmark of Silgan, and that is what creates a moat. We must continue to work and not rest on laurels, but current evidence indicates the team has created a meaningful competitive advantage in service and capability.

It appears there are no further questions. I'd like to turn the conference back to Tony Allott for any additional or closing remarks.

Great. Thank you. And thank you all for your time today and we look forward to talking about our first quarter of 2021 late in April. Thank you.

That concludes today's call. Thank you for your participation. You may now disconnect.