Silgan Holdings Inc
NYSE:SLGN
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Thank you for joining the Silgan Holdings Fourth Quarter 2018 Earnings Results Conference Call. Today's call is being recorded.
At this time, I would like 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, President and CEO; Bob Lewis, EVP and CFO; and Adam Greenlee, EVP and COO.
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 2017 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.
Thanks, Kim. Welcome everyone to Silgan's 2018 year-end earnings conference call. I want to start by making a few comments about the highlights of 2018 and provide a brief update regarding the 2019 outlook. Bob will then review the financial performance for the full year and the fourth quarter, and provide more detail around our 2019 outlook. Afterwards, Bob, Adam and I will be pleased to take any questions.
As covered in our press release, 2018 was a very good year for the Company with several record performances and milestones, including delivering net income per share of $2.01; delivering record adjusted net income per share of $2.08, 26% above the prior year record level; generating free cash flow of $311.4 million or $2.79 per share, an increase of 39% versus the prior year; and a free cash flow yield at year-end stock price of 11.8%; renewing a long-term contract with our largest customer through 2025 and positioning us to further support their growth objectives; exceeding inventory reduction targets in our U.S. metal food can business; continuing strong growth since further accretion from our dispensing systems operations; delivering another year of significant improvement in our plastic container business; commercializing two new manufacturing facilities to support growth in the pet food market; rationalizing can manufacturing operations in two metal container facilities; completing a favorable amendment to our senior secured credit facility and redeeming all of our outstanding 5% Senior Notes; and finally, increasing the cash dividend by approximately 11%.
We're pleased with the performance of each of our businesses in 2018. Earnings growth was primarily driven by the inclusion and strong performance of dispensing systems operations, as well as continued improvement in our plastic container business.
As expected, the improvements were partly offset by the metal containers business as we focused on cash generation and incurred on a $18 million headwind for un-absorbed overhead cost as we worked down finished goods inventories.
Volumes in metal container business were down 4%, but these were the result of a few specific customer actions while the rest of the food can industry grew during the year, reflecting the continued relative stability of the metal food can and our end markets. We believe our businesses are also well positioned in 2019 and anticipate solid earnings growth before considering the impact on pension costs for market declines late in 2019.
Therefore, as Bob will discuss in more detail, we're providing full year guidance for the adjusted earnings per diluted share in the range of $2.10 to $2.20, which includes a $0.13 per diluted share for the unfavorable pension impact. The midpoint of this estimate represents almost 10% increase over our record 2018 earnings, excluding the pension impact. We also expect free cash flow to be approximately $275 million.
With that, I will turn it over to Bob.
Thank you, Tony. Good morning, everyone.
As Tony highlighted, 2018 benefited from several strategic initiatives which leave our business is well positioned for 2019 and beyond. These initiatives included deployment of growth capital on our plastic and metal food container businesses, right-sizing our inventory levels to generate incremental free cash flow, initiating plant rationalization activities, renewing the long-term contract with our largest customer and completing the integration of the dispensing systems operations.
As a result, in 2018 we delivered adjusted earnings per diluted share of $2.08 and we delivered free cash flow of $311.4 million. On a consolidated basis, net sales for the year were $4.450 billion, an increase of $359 million or 8.8% over the prior year. This increase was a result of revenue increases across all of our businesses.
We converted these sales to net income for the year of $224 million or $2.01 per diluted share as compared to 2017 net income of $269.7 million or $2.42 per diluted share. In 2018, adjusted earnings per share benefited by adjustments that increased earnings per share by $0.07 for restructuring costs and loss on early extinguishment of debt.
Adjustments decreasing earnings per share in 2017 totaled $0.77, including a decrease of $1.00 per share and a net tax adjustments reflecting reduced future cash tax obligations under the US Tax Cuts and Jobs Act of 2017 and increases of $0.15 for cost attributable to announced acquisitions and $0.08 for restructuring costs and loss on early extinguishment of debt.
As a result, adjusted net income per diluted share was $2.08 in 2018 versus $1.65 in 2017, an increase of 26%. Interest expense before loss on early extinguishment of debt increased $6.1 million to $116.3 million primarily due to higher weighted average outstanding borrowings, principally as a result of borrowings to fund the dispensing systems acquisition in April of 2017 and higher weighted average interest rates.
In addition, we incurred a loss on early extinguishment of debt of $2.5 million as a result of the redemption of all the remaining 5% Senior Notes due 2020 in April of 2018 and the amendment to the senior secured credit facility in May 2018. In 2017, we incurred a loss on early extinguishment of debt of $7.1 million as a result of the prepayment of outstanding US and euro term loans under the previous senior secured credit facility in conjunction with the issuance of the new Senior Notes and the April 2017 partial redemption of the 5% Senior Notes due 2020.
Our 2018 effective tax rate was 23.6% versus a negative 12.5% in 2017. The 2017 rate was favorably impacted by the benefit from the effective tax rate adjustments totaling $110.9 million or $1.00 per share.
These adjustments are primarily the result of the revaluation of net deferred tax liabilities to reflect lower future tax obligations as a result of the reduction in the US corporate tax rates under the U.S. Tax Cuts and Jobs Act of 2017. The effective rate for 2017 exclusive of these effective tax rate adjustments would have been 33.8%.
Full year capital expenditures totaled $191 million in 2018, which is slightly lower than anticipated as a result of the timing of the completion of certain projects which will carry over into 2019. Capital investments in 2018 totaled $174.5 million. Additionally, we paid a quarterly cash dividend of $0.10 per share in December. The total cash cost of the dividend was $11.1 million.
For the full year, we returned $44.5 million to shareholders in the form of dividends. As outlined in Table C, we generated record free cash flow of $311.4 million or $2.79 per share versus $224.1 million or $2.01 per share in the prior year.
I'll now provide some specifics regarding the financial performance of each of our businesses. The metal container business recorded net sales of $2.380 billion, up $99.9 million versus the prior year. This increase was primarily due to the pass-through of higher raw material and other manufacturing costs, and the impact of favorable foreign currency translation of approximately $12 million, partially offset by lower unit volumes of approximately 4%.
The reduction in unit volumes was principally due to a few specific causes we have been discussing all year, namely, a seasonal customer reducing inventory levels, a customer plant shutdown in the fruit market, a competitive loss of a smaller customer and a less favorable harvest in Europe.
These declines were partially offset by higher pet food volumes and an incremental buy ahead by customers in 2018 in anticipation of significant steel inflation in 2019. Segment income in the metal container business was $198.8 million, a decrease of $31.4 million versus the prior year.
This decrease was primarily attributable to the unfavorable overhead absorption of approximately $18 million due to the reduction of finished goods inventory by approximately $65 million, lower unit volumes, higher freight expense and higher rationalization costs.
These costs were partially offset by the favorable impact from the contractual pass-through to customers of indexed inflation on non-metal costs as compared to the unfavorable impact in the prior year from the contractual pass-through of indexed deflation on non-metal costs, lower manufacturing cost and a charge in the prior year related to the resolution of a past noncommercial legal dispute. We also incurred rationalization charges of $5.3 million and $3.3 million in each of 2018 and 2017, respectively.
The cost in 2018 are primarily a result of the liquidation of the business in Belarus and the shutdown of operations in Jordan. Net sales in the closure business increased $210.1 million to $1.460 billion in 2018, primarily due to the inclusion of the dispensing systems operations for a full year, the pass-through of higher raw material and other manufacturing cost, and the impact of favorable foreign currency translation of approximately $18 million.
These benefits were partially offset by approximately 2% lower volumes in the legacy closure operation, primarily as a result of less favorable fruit and vegetable pack in Europe due to poor weather conditions.
Segment income in the closures business for 2018 increased $47.9 million to $189.9 million, primarily due to the inclusion of the full year of dispensing systems operations, the unfavorable impact in the prior year of a one-time $11.9 million write-up of inventory of the dispensing systems operations for purchase accounting in the second quarter of 2017, lower manufacturing cost and foreign currency transaction losses in the prior year period, partially offset by volume effect from a less favorable fruit and vegetable pack in Europe.
Net sales in the plastic container business increased $49 million to $614.1 million in 2018 principally due to the pass-through of higher raw material cost and higher volumes of approximately 4%.
Segment income increased $14.8 million to $42.6 million for the year, largely attributable to higher volumes and lower manufacturing costs, partially offset by cost associated with the startup of the facility in Fort Smith, Arkansas.
For the fourth quarter, we reported earnings per diluted share of $0.34 as compared to $1.31 in the prior year quarter. We reported adjustments increasing income by $0.04 in 2018. And during 2017, we recorded adjustments reducing earnings by $0.99 per diluted share largely as a result of the net tax adjustments reducing future tax obligations. As a result, we delivered record adjusted earnings per diluted share of $0.38 in the fourth quarter of 2018 versus $0.32 per diluted share in the same quarter a year ago.
Net sales for the quarter increased $74.8 million versus the prior year, driven primarily by the pass-through of higher raw material and other manufacturing costs and an increase in volumes in each of the businesses, partially offset by the unfavorable impact from foreign currency translation of approximately $8 million.
For the fourth quarter 2018, volumes increased by 4% in each of the metal and plastic container businesses and 1% in the closures business. The volume improvement in metal food containers was principally due to a larger buy ahead by customers in anticipation of significant inflation in 2019.
Income before interest and income taxes for the fourth quarter of 2018 decreased by $9.1 million to $77.3 million, primarily as a result of the unfavorable overhead absorption of approximately $18 million in the metal container business due to the reduction of finished goods inventory by approximately $65 million, higher SG&A costs, higher rationalization charges and cost associated with the startup of the new plant in Fort Smith.
These costs were partially offset by higher volumes in each of the businesses, lower manufacturing costs, a favorable mix of products sold in the closures business and a favorable impact from the lagged pass-through of lower resin costs in the closures business. The effective tax rate for the fourth quarter of 2018 was $23.1 million versus a negative 159.2% in the prior year quarter.
During the fourth quarter of 2017, we reported effective tax rate adjustment of $110.9 million primarily due to the revalue of net deferred tax liabilities to reflect lower future tax obligations due to the reduction in the US corporate tax rates. Exclusive of these adjustments, the fourth quarter effective rate would have been 37.6%.
I'll be turning now to 2019. Our estimate of adjusted earnings per diluted share for 2019 is a range of $2.10 to $2.20, which includes an unfavorable non-cash pension impact of $0.13 resulting from significant market declines in investment values at the end of 2018. This estimate compares to adjusted earnings per share of $2.08 for the full year of 2018.
Reflected in our estimates for 2019 are the following: segment income in the metal container business is forecasted to benefit from a normal production level in 2019 as compared to the significant finished goods inventory reduction in 2018 and continued manufacturing efficiencies offset by the unfavorable pension impact and anticipated lower unit volumes.
The expected decline in unit volumes is primarily the result of the customer pre-buy activity in 2018 in advance of the anticipated steel inflation and expected continuation of an inventory and portfolio management program at a certain customer. These negative drivers are expected to be partially offset by continued growth in pet food and a more normal fruit and vegetable pack in Europe. The closures business is expected to benefit from anticipated volume gains and continued manufacturing efficiencies, offset by the unfavorable pension impact.
We are expecting the plastic container business to benefit from continued manufacturing efficiencies and volume growth, including from the new Fort Smith, Arkansas facility. These benefits will be partially offset by the unfavorable pension impact. In addition, we expect interest expense to decline slightly versus 2018, largely a result of lower average outstanding borrowings, partially offset by anticipated higher interest rates. We currently expect our tax rate to be approximately 24%, largely in line with the 2018 rate.
Also, we expect capital expenditures in 2019 to be approximately $200 million as capital for certain projects initiated in 2018 will be paid in 2019. We're also providing a first quarter 2019 estimate of adjusted earnings per diluted share in the range of $0.40 to $0.45, excluding rationalization charge. This compares to $0.42 in the first quarter of 2018.
We anticipate slightly higher volumes in the closure and plastic container business, continued manufacturing efficiencies across all businesses, a more seasonal inventory build in the metal container business, a favorable impact from the lagged pass-through of lower resin costs and lower interest costs, as well as lower unit volumes in the metal container business and the unfavorable non-cash impact of approximately $0.03 per diluted share.
Metal container volumes are expected to decline as customers utilize product purchased as part of the strong pre-buy at the end of 2018, the continuation of the inventory and portfolio management program at a certain customer and the continued impact of smaller customer loss, partially offset by higher volumes in the pet food.
Based on our current outlook for 2019, we expect free cash flow to be approximately $275 million versus the $311.4 million in 2018 as 2018 benefited from a significant reduction in finished goods inventory which is not expected to recur, and slightly lower CapEx. Additionally, 2019 will benefit from improved earnings and lower cash interest.
That concludes our prepared comments. So in an effort to allow everyone to have their questions answered, we'd like to ask that you limit your time to one question and one follow-up and we'll be happy to take additional questions if you want to get back in the queue.
So, David, I'll turn it over to you for directions for the Q&A.
[Operator Instructions] We'll take our first question from Anthony Pettinari with Citi.
Just had a question on the 4Q metal container volumes, I think they were up 4% on pre-buy activity. The CMI data was sort of flat. Did you meaningfully outperform your peers or is it possible that the pre-buy benefit was intact by CMI? Or do your customers may be pre-buy more than peers? I'm just trying to kind of parse up the details there.
So yes we are 4%. That increase is entirely driven by pre-buy and little bit more we would have been down had there been not been pre-buy activity in the quarter. You're right that the market was more flat in the fourth quarter, but I think if you look back to the fourth quarter a year ago, the industry was up I think somewhere in the 3% 3.1%. And that we attributed at that time to our understanding that the pack in the Midwest particularly, Southern Midwest was much stronger, which we are a little less represented by. So I think the answer is that our peers had a strong fourth quarter a year ago and that, that was a tough comp for them.
And then just it seems like this year may be later in the year you'll be in a position where you could potentially repurchase shares, but you've also had some success with the HSMB acquisition. Just wondering if you can talk about the M&A pipeline broadly and then kind of the attractiveness of M&A versus repurchases?
Yes. Well look Anthony, we're doing well against our cash flow guidance. We are delivering I think that speaks to the strength of the franchise. Remember with the deal back in April of 2017 we kind of levered up to the mid-4s communicating that we'd be able to get pretty quickly back into the range. As we exited '18 we're kind of right at the top end of that range with a $275 free cash flow target next year. That will put us closer to the midpoint.
So I think more than anything from a capital deployment standpoint that puts us exactly where we would want to be to have the flexibility to be able to take advantage of M&A opportunity should they arise further deliver if there is a short-term absence of M&A opportunities. And then look as we've always done at a return to capital if it's a longer-term kind of slowdown in M&A activity.
But I wouldn't at all think or say that there is that kind of slowdown. I think there's some nervousness around with the credit markets have done. I think they've settled down a little bit more recently.
I think there's quite a bit of activity in the marketplace around the M&A space and there's certainly things that we would have interest in looking at. None of that necessarily means that we get a deal done, but there are certainly things that we would want to look at and I think that's where we would see if the capital allocation as a consequences.
And next we'll go to Scott Gaffner with Barclays.
Bob when we you were mentioning the puts and takes in 2019 for the metal container's business, I was just wondering if you look at the pre-buy and some of the compression issues that's going to create for 2019 do you still think that you can get the positive year-over-year operating profit in metal containers business?
Scott its Tony. So you didn't go where I thought you were going on that question. So the answer is yes, we do think we can get positive operating profit. Remember that the metal container business had this $18 million of inventory overhead cost on the year. So that's kind of a meaningful benefit we climb against on that. And so we do expect that even though there's going to be a significant pension impact that we will have that benefit.
Where I thought you were going to go and I thought I was running on volumes. So it is we are expecting volumes to be down next year, but the primary reason for that has to do with the pre-buy. And I want to take a minute because it's worth looking at the impact of pre-buy. There is significantly negatively impact on the year that follows a pre-buy because you have the year before that has the sale that you in the first quarter of the year following you do have those sales.
And then by the fourth quarter you're cycling against the prior year on the compare a bit and you essentially end up with two times the hit on competitive percentage. So the majority we think volume be down in 2019 is nothing more than the pre-buying you saw at the end of 2018 and yes that compared to the prophet can get back to positive, but if you do have to come over a significant pension impact. So that's why we're saying we'll be pretty modest.
And just as far as the pre-buy that was going to be the second part of my question actually is just do you feel the pre-buy in both Europe and the U.S? And was that across various customer segments? Or was it particular to certain customer segments?
Good question. So the pre-buy was not in Europe. What's happening in the steel markets are quite different between Europe and the U.S. So there would have been not a lot of reason in Europe to do a pre-buy and as you'll recall it's a pretty negative pack season there. So there was really no reason to try and maybe doing that in any case.
So were there certain markets here I would say that yes it probably skews a little bit more to the vegetable market just because those are the customers who typically can theoretically do that pre-buy. And so it's definitely domestic and it would probably be a little bit more as you look at industry data, it sits a little bit more in the veg category.
And next we'll go to Mark Wilde with Bank of Montreal.
Tony, how about we could just walk over to the closures in dispensing business and if you could just help us unbundled volumes both in the fourth quarter and the full year between closures and dispensing?
I'll jump in on this one Tony you can correct whatever I get wrong to start with, but if you look at the fourth quarter, we did see again continued growth in the Dispensing Systems business. So their volume was up about 3% in the quarter versus prior year. And if you look at the legacy business, importantly the U.S. singleserve market that we've been talking about for some time now is we had previously said we thought the back half of the year was going to see a recovery mostly because we had very difficult comps in the first half of the year.
We did see growth of about 2% in the U.S. singleserve business in the fourth quarter as well. Those are largely offset or partially offset by some continued weakness in the European food pack. So if you kind of break it down, I'd say dispensing up 3% the important U.S. singleserve market up 2% and Europe down just a couple percentage as well. And then if you look at the full year, you go ahead Mark, sorry.
No. That's exactly where I was doing the full year.
Okay. So full year dispensing systems as we've talked is kind of a mid-single-digit kind of unit volume growth business and it delivered exactly as expected. So we're kind of mid-single digit or hustle closure business in the U.S. the singleserve market we just talked about, all told we came in about 2% down versus prior year, again I'll just say as expected. And then the unfavorable volume impact was really Europe and it's mostly related to the food pack that we've been talking about for some time. So the interesting thing with that is the closure isn't necessarily a closure.
So with some weakness in the European food pack, a pick-up in volume and dispensing systems, we actually had a favorable mix in our closures business as we look at the total as well. So all in I'd say a pretty solid year and a very good end of the year in Q4 for 2018.
And if I could Adam just as a follow on, when you bought this business, you talked about the potential for kind of bolt-on M&A in that business and I wondered if you could just update us on how you're thinking about that right now?
Yes Mark this is Bob. That is it you're right. We did say that. We thought that there will be opportunities across the globe to think about the various silos of product line around that business and that we'd be able to over time find areas where we could invest and further grow. That is the focus of our M&A strategy. Obviously we've not announced one as we sit here today but it is something that we still think that we can avail ourselves to and we'll present opportunity over time.
Tony let me out one more point on that which is that we also see opportunity for a great growth in that business and investments on organic growth towards. So some of this is acquisition based some of is that we're just having success going with customers and markets and can also take the root of organically investing on that.
And next we'll go to Clyde Dillon with Vertical Research.
I had a quick question a couple. One has to do with the pet food area. I know 2017 you saw a big pop like 7% and then I think you mentioned I think last year it was moderated quite a bit. And I just want to know what your thoughts are about ped foot going forward? And frankly have seen a lot more in houses et cetera and I didn't know if there's if you are at if that's going to have an impact?
Okay. We continue to see petfood is a pretty solid and growing area across our businesses. And so if you look at kind of ped population percentage household with pet those numbers continue to be up 5% 6% 7% 8% depending on which stack you kind of look at. We think that food will grow. You are right that if sometimes it moves in it's not a linear straight line up. What happens if you got promotional activity that throws up quite a bit. So you'll have your our history on that as we see significant growth and then we'll have a years that are flat maybe give a little bit back.
But over time pet has been a steady growth and we think it will continue to be. And we think the kind of packages our customers chose they do it for a lot of different reasons. So the we feel really good about what is in can pet food makes a lot of great progress at this true with all of our packages it's fully recyclable consumers like it and that works well.
Other customers are working more at plastic solutions and that's something else that we can deliver for them. So we're little bit agnostic not towards pouch but really we don't see a lot of pouch in North America in any case.
That several. And then just a quick follow. You mentioned that when you were with a big customer in 2025 and you didn't know if this year in the future they'll be a significant capital component maintaining that business. And is it fair to say it's typical of renewals where maybe during the year if you might give up a little bit of margin but expect to get back to that and more in the later years?
Good question. I don't want to get into any specifics. I'd say a couple of things on that. One is that it is a business that we anticipate growth over time and has grown historically and we have invested behind that. So yes they will be kind of ordinary course capital investments to support the growth on the business as we go forward.
On the renewal I would just say that I will call are typical of our contract renewals will be trying to go into each of them and find win-win. Obviously the customers looking for value of some kind and we're trying to find cost savings growth opportunities et cetera. And so we really no different than other contract. We're trying to find a solution that's good for both parties on that and I would say this one fell right into that category.
And next we'll go to Gabe Hajde with Wells Fargo Securities.
Had a question about the closures business. To the extent that there is any sort of exposure to I guess the Chinese consumer or some of these fragments or beauty and personal care products find themselves in duty-free shops and stuff like that have you had any dialogue with customers that're a little bit cautious on the environment? Just a little color on that front.
Sure. So a relatively small portion of our closure sales are into and for the Chinese market. A big part of our Chinese footprint is to have a lower labor cost means to supply markets around the world. So that doesn't mean we don't sound in that market. Of course we do but it's pretty small and you can id say fair there has been some softening of more higher personal care kind of markets that we fell into but it's small enough towards it's not a meaningful part of the financial performance.
And I believe you mentioned it but is there any way to parse out is there an expected kind of risen benefit you in the first half where things have turned in the plastics business and closures business?
Sure. I think in total give you're probably a couple million dollars of benefit in Q1. And then what we do as a company our policy on the forward-looking resin for the budget is we then we hold risen flat for the remainder of the year. So obviously that wasn't markets are volatile right now we've seen some drops as we come into the year. Depending upon the resin type you're talking about there will be some stabilization. Primary resin certainly risen will go up as well particularly .
So I think as we sit here today it will be of a small benefit in the first quarter and that should not have much of an impact on the course of the year. The real reason for that is we've got a nice job systemically reducing kind of our exposure to the lagged pass-through of resin in our core businesses over time and had shortened those pass-through mechanisms. Dispensing systems is one might business that has slightly longer lags. So that's where you are seeing more of an impact for our business.
And next we'll go to Debbie Jones with Deutsche Bank.
I wanted to ask about the client rationalizations that you mentioned. I didn't catch specifically where those were. I think might imagine something injured and the tightening of that? And whether or not you've already started to see a benefit? I mean if you could just comment on why those figures remain?
Sure. Basically the charges that we've incurred in the year related to two primary facilities. We closed a facility out of the European operation in Belarus and we ceased operations in Jordan. Remember that both were relatively small facilities for us each of which were part of the geopolitical landscape. So it made sense for us to do that.
Given most of that activity has been influencing the operations of those two entities for the last year or 2 there really isn't much benefit to be had three other than just not have the destruction of trying to operate those facilities and navigate those waters. So the impact wouldn't be very significant in the overall P&L as we move forward.
And then Debbie I think maybe a more general about other rationalizations that could come from there. I think the we've basically in our can business we've shut down nearly a plan for the plant to operate. So we're constantly looking at the footprint and the opportunities on the. As you've heard from us over the last year we're really waiting and watching a little bit to understand a particular set of customer actions. If volumes remain where they are now there's more opportunity for us to do that and we certainly will get at that and do it.
If volumes were to come back a little bit because customers have been working off inventories and doing some portfolio management if that ends and they see a different forward-looking number than we would have a little less of that or do. But we're absolutely looking at it and I think it's a reason to assume that there could be some more going forward.
The second question is around on the potential impact or what you're watching for when you think about the perception around flat forward Is the dispensing closures would consider maybe a little more immune to some of those concessions? And then secondary to that does any of this discussion around perception around this issue impact your M&A strategy going forward? And even some of the multiples that you might be seeing in these businesses?
Sure. You broke up at the beginning but I think lots of the question was what are we seeing around flat plastics concerns about ocean plastics and impacts On first of all our businesses and then on our M&A strategy. So we talked about before. I think the where the heat is most is around one direction one use packages. That is not the bulk of our plastic container business for sure. It and it also is not around our dispensing systems business.
So really the one area that is mostly in that issue is going to be around other flat closure business primarily to the hospital market. Know that closure add a lot of benefit in terms of maintaining vacuum etcetera. So it's not just a dust cover like you said around the watertight ledger. So really our thinking there first of all right now we're seeing an impact meaningful on that at all. I think what is possible is the technology around that closure may change. It may governments may want it to be tethered to the border to enhance recycling.
That's something that we would be kind of advantaged in developing and getting that into our customers. So we're really at this stage do not see significant risk around our existing businesses on this ocean plastics area. I will deviate again and say I do think the industry have to get better about recycling the industry is getting better about recycling. There is a lot that we as participants in plastic industry need to do more and help it.
So I'm not walking away from that point at all but I think the kind of where the volume is going to move it does not seem to be an area as we think affect us. Does it affect our M&A strategy? Sure. You to have to think about what markets are going to be effective and I think there are some that are definitely have some impact around this the CST water being probably the most likely area. So yes, it is something you have to think about.
Next we'll go to Ghansham Panjabi from Baird.
This is Matt Krieger sitting in for . so my first question is where your inventory reduction efforts even more pronounced than you expected given the volume upside associated with the pre-buy in the metal container's business? And then could we see any sort of swing back from a working capital perspective in the 2019 because of that?
Good question Matt. So absolutely we've got more inventory out than we had originally set as target. We were thinking kind of in the $50-ish million range and we actually got sort $65 million. One of the things that helped us very few but one is the demand. You did kind of get a spike in demand at the end of the year and we chose producing it wasn't move out of inventory. So that I think was great for us. It created kind of P&L hit which more or less offset the volume gain that we had in the fourth quarter. So it kind of worked out well in that regard.
It did allow us to generate significant cash flow. We did not think of a swing back. Our intention is to hold these inventory levels. And so we don't think of swing back but honestly you won't get the same benefit again. The $65 million was sort of a one-time thing. So when you look at the free cash flow you can't duplicate that but we are not expecting working capital swing back we are staying very focused on our capital.
And then as a follow-up can you quantify what you expect in terms of stealing template inflation by region North America and Europe? And then what do you expect in terms of a price mix impact across the metal container business as a result into 2019?
Sure. I can I'll try the second one. First which our intention in our business model pass-through whatever we get. So I'm not going to actually blended into our revenue for you. But basically our business model is to pass through our exposure and earnings release cost. So what we're seeing in North America is as you recall we had came in to comment middle of last year to the 225% on steel 10% on aluminum that affected the instruments brought that's some 30% of our buy because Canada was ultimately included in that.
So if you now look at the U.S. suppliers they are not looking to come in right underneath the tariff. And so you're talking about increases there in the high teens to low 20-ish percent range in North America. So we're going to see a significant increase across our North American metal business. Europe on the other hand is not so much of that. There is a little bit of quota is being established so that the Asian markets not dumped into Europe but I don't think they're changing in that market all that much. There's plenty in it by capacity. So this is that in that market mid-to low to mid-single-digit kind of increase. So very different dynamics in the two markets in this coming here.
Next we'll go to George Staphos with Bank of America Merrill Lynch.
Congrats on the years of finish money and buy. First question I had was on just demand again in food cans. Recognizing you're looking for it to be down is there a way to put up a finer point on it for both the quarter and the year? Recognizing it's in the January and a lot of things can change. And relatedly when we have any kind of view on what the customer in questions plans are for their portfolio down the road?
So I think with the quarter giving first quarter and year 2019. And so absolutely as a buying forward that we saw in the fourth quarter is going to affect the first quarter. So we're going to be down probably somewhere in the range of 6% will be able to take right now in that first quarter so a significant down you get remember now that's rental relatively small quarter so you get kind of a sizable impact on that.
On the year as we've said we're thinking down about 4% but majority of that 3% are there is nothing but that buy forward in the way it affects kind of doubling intact the comparison of the two years. So beyond that we're really it's mostly about the when customer who is still talk about some more inventory reduction. And then you get a little bit of carryover at some of the impact. There was a small piece of business with loss in middle of the year gets carryover impact that. Against that we do believe that Europe should have a better pack season. You're getting pick up something in Europe.
We do think you'll see this growth that we talked about in the pet food side. Soup is a little bit more of an unknown but right now looks pretty good on the soup side . So those kind of moving pieces on and what we expect for next year.
And my follow on recognized this year you have a couple of items were kind of one-off you have the reabsorption of overhead which will have the earnings. You have steel going up which affects you on a percentage basis doesn't really affect you on a dollar basis and EBIT. When I think about some other components that shift to pet food in your mix if there's any kind of nonmetal pass-through this year? It had a bit of factors blend together in terms of what a normalized margin or return would be . Do Those factors help you this year? Do those factors hurt you this year?
Sure. So reabsorption is I want to be clear we're not kind of rebuild inventory. So all you get is you no longer have the over absorption coming through our fill rate. So yes that's not having that issue comes through helps us. The tension a sizable and some near half of the total pension issue comes right through the food can business. So there's not an unimportant.
And as we've said you've got this volume compares an issue. And so those are the big moving parts. The rest is that our business has continued to do a really good job of controlling its cost. We expect to continue to see that and so that's kind of the paddling that goes on underneath the water that you don't see as much. And so the net of all that gets us back to it should be slightly positive after the pension.
Next will go to Daniel Rizzo with Jefferies.
Just in terms of pre-buying that you said was kind of a tailwind. Is in general does pre-buy generally and at the end of the calendar year? Or can it extend into next year? That is it I mean could it be a short-term tailwind here in the first quarter?
No. Nearly all of our contracts in North America start up again on January 1. So there you would not expect anything to carry into this year.
And then you mentioned tethering and the issues around sustainability. I was wondering how the sustainability affects the singleserve market? If you were to make to be tailwind as it pushes towards more recyclable products and more recyclable products?
So if I understand your question you'd said more of a tailwind for the canned business because issued on the plastic side was plastic singleserve?
Well yes.
Yes so absolutely there is some logic to that. I mean let's start with the fact that the steel can is infinitely recycled the most recycled package in the world. It's easy to recycle in a magnetically attractive to kind of everywhere cycling place and is resorted. And so there is a lot of really good reasons on why you should see more of that. There are some examples where we're hearing from customers on it. But I would not say that's big point yet but I would just leave the thing and from the metal can.
And next we'll go to Adam Josephson with KeyBanc Capital Markets.
Tony just one more on this plastic issue. I know that I think even some of your customers have talked about kind of shifting some of their business from metal to standup pouches correct me if I'm wrong there. So it's not clear to me the that this shift would be an opportunity for the metal can. Why do you think it would be?
Well so let's I'm not sure. What I said I think if anything it certainly can't hurt. I think it would be because ever thing I just said. As they dissented recycled package there just a blip I remember I can't go in the flexible work I think the world is coming to realize pouches are one hell of a problem on them. They have lots of recyclability problems. So yes it lighter content but we do with them at the end.
And so you've got to separate materials and then you've got to talking about food products return products et cetera unitary value you're getting lots of layers a lots of stuff in those pouches as we don't know. So but the pouch has been there forever. I mean the cans can compete with the pouches be with a pout for as long as the pouches have been out there.
So I think what's happening is unbalanced now. There's a question about the thousands of what happens to the recyclability chain. They weren't here five years ago. So I think the balance of the canvas of the payout. And I just think our customers will have to think twice before you move into any plastic product right now.
And just back to food can value for a moment. You were down 4% in 2018 and then you're guiding you assuming about the same in 2019. And the pre-buy washes out because it boosts one year and it's a drag on the other year so bottom line you're down probably 4% in 2018 and 2019. And I know you had some one of customer affections and inventory reductions et cetera but what gives you confidence that he will go from down 4% and down 4% to flat thereafter that he wouldn't have additional customer losses or inventory reductions et cetera comparable for what you've recently been experiencing?
First off I'll encourage you to go look at the mall. It's actually not correct. it does not wash through. If you take pre-buy's out entirely of 2018 it was still down 4%. Now some of that because it came in with smaller pre-buy. But then again I would say when you look at percentages the pre-buy is twice as damaging at the West follows the year gets it. And I'll leave the mess right now of the table. So actually I would say what you're looking at and what we do told you its 4% down in 2018 and 1% down and 2019 because pre-buy writes the other 3% of 2019.
So but your questions as to what makes us have confidence? The that's why we take various specific items. So yes a customer who shut a plant at very specific deception impacts of that. You had a sizable customer who willingness a major inventory reduction. So that's just in the stream reduction of inventory. Unfortunately I can't tell you exactly how much is inventory reduction versus walking away from certain portfolio management programs.
So if I do the exact on that then I can give you a clear answer. But as the portion with inventory reduction there is no logic I can be aware of and have some recovery of it. You can't keep working down you're inventories. So those are the best I think our feeling has been clear with couple of discrete items going on. Our head is not in the can.
There are Some markets can that are declining. Right? We said pretty clearly student has declined as there but as you said in the last call again that there were also just as clear that pet food is increasing and pet food is by far our largest individual component now and becomes larger with each year of growth on that. So that's what makes us feel pretty confident that over time this is going to be a flat-to-modest growing situation for Silgan as we look forward.
And next we'll go to Brian Maguire with Goldman Sachs.
Just another question on the back to the pre-buying. Just wanted to how do you actually know the extent of the pre-buying activity as it's happening. Customers kind of give you I hate that what's going on there? Or do you just use out of Alberta ordering? And sort of related to that do you think more to the negative impact to 2019 will be felt in 1Q? Or the seasonal needs of somebody's products it'll be more spread out through the year?
Sure. Good question. Actually we have a really good knowledge in almost all of that. And so as to when it happens the customer we have very specific order of patterns of expectations. We have to get our customers need. So when the customer asked for a pre-buy they did not tell in advance that they're doing that. And so we have quite good clarity. There are couple of customers who they can order a little bit more. But on balance we kind of knows the pre-buy on it. Yes most of his will show in Q1.
There are some customers that pack might be Q1 and Q2 they spread a little bit in Q2 they will spread this as we look onto becoming again in Q1. Got to be repetitive you'll see it in our comps in two spots. You see it in Q1 where we don't sell the can and you'll see it in Q4 when we compare against the prior quarter where we did sell the can.
Yes, it makes sense. And likewise I assume some positive comps in 2Q and 3Q as you sort of lap inventory drawdowns some of the customers you called out. But just one last one just on the working capital assumptions in the cash program is. I think in response to Meth's question earlier and said it's not going to be of use of cash. Just wondering if you assuming that and I know you talked about trying to break down some more inventory on the margin. But can you just take working capital to be a source of cash in 2019?
Yes as we look into 2019 quite frankly as we've done for the last several years so we took some I think it was $30 million or so out of 2017 we took $65 million out of 2018. We would expect to be able to marginally improve as we move into 2019. But to be clear on it if you're walking and cash flow from the $311 million to the guidance it's just fairly sizable negative drag on free cash flow on a year-over-year basis. But in pure dollars it is expected to be a small benefit for 2019.
Okay like $5 million $10 million kind of range or a little better than that?
Yet it's a probably little more around $10 million.
And next we'll go to [indiscernible] with JPMorgan.
Yesterday question on something. Higher freight rates in 2018? And then just what could happen this year?
Sure. It's I don't I think given specific numbers but several million dollars the impact on freight this year and some of that of course. That's what we talk of the customers tell more about it obviously. We are expecting some continuation of that around a year-to-year comparative basis we're not right now expecting freight a meaningful change in the cost structure.
And then just on plastic because you could give the volume growth you're expecting this year and sort of the ultimate target they got served a 15% EBITDA margin. I consider sense on more line of sight on what you can get there and how confident you are in hitting that?
Sure Tylor [ph] its Adam. We continue to make really good progress towards get into our goal of 15% EBITDA margins. We said in 2018 it will be around bit lumpy if new businesses won't comment and the seasonality of the business. And I think we'll see more of that in 2019 as well. But our expectation is that we'll achieve the 15% EBITDA margin run rate at some point in 2019. again I will be careful to say they will be some stability in the business. But we expect growth and we expect continued improved operational performance in the business and expect to achieve our target.
And next we'll go to Arun Viswanathan with RBC Capital Markets.
I guess the first question I had was on the pre-buy. Is there a certain remove that potential aspect? Is that and considered? Is that Customers will be open to receptive to? Maybe just give me a thought on that.
Yes the answer is no. If we can source the materials for them and we have the material on hand we're perfectly willing to let our customers enjoy the benefit of that. I think some of those is really way back to the way Silgan things about our business model which is really driving competitive value to our customers so our customers can win in the market. So if we if we've got a big inflation item and we can help them with that we're going to do what we can to try to help them do well in our markets ways.
And no we're not trying to model ourselves away from that. Again we don't lose interest rate. We might lose there might be an opportunity cost will be can have most children get a benefit next year but all the rules as an opportunity cost but we don't close in exchange. It's for us is in the right rate to make for our customers.
Great. Just another question on the container business overall longer term. A couple of quarters discuss that there could be customers that always kind of take quick volume shifts . So longer time as you look at the medical computer industry and what you think food can scan should grow flat? and use the flat and negative there. I think what's the growth rate for petfood and how large there's become as part of the portfolio? And similarly for soup and fruiters and the deteriorating categories? And how small candles really become and still be meaningful prefilled cost absorption with the new system?
Sure. I'd walk to that. I think what we earn they can do is we're feeling that looking at flat as a reasonable answer right? I would say flat to modest growth. I think flat a modest decline. I think either of those let's ourselves a kind of flat. I think the what happens over time from Sagan's perspective particularly is the growth the pet food overcomes the rest of the decline. So rude that's been declining steadily with regard to continue and that is a very small I think 4% of our portfolio today.
If you look at vegetable market there has been some decline over time but a lot of the seconds of vegetable decline are getting quite decline corn and tomato which is much more stable. So again we were to maybe a little bit crooked with on an adventure point our thinking as well point is as you're looking what's out there in terms of numbers and pets et cetera. Something in that 3% 4% seems very reasonable to us. I could be at think 5% I would be a little aggressive 3% or 4% makes a lot of sense to us.
And next we'll go to Edlain Rodriguez with UBS.
One quick 1. Last quarter you've talked about walking away from certain customers. Is that still the case? Or have customer losses come to an end?
Good question. We certainly hope that it come to an end. Again what we're trying to convey is not that we want to walk away from customers but rather that there are some business that the margin does not justify fighting it out. There is some excess capacity in the market space. So I believe our industry has made cents from time to time to do that. I think our feeling is we have done that and we don't really choose to do a lot more of that that the market is at a reasonable spot right now.
We probably can't take some capacity out just in what's happening today. Again as long as we understand what the run rate is for the customer we've been talking about. So then we are working perfect because it would not be your expectation to be conceding a lot more market in the market and there's very cost structure just like everybody else in the market. That does not work at certain point. So the food is okay it's not our business strategy.
That makes sense. And in terms of the customer that is doing the inventory management do you have a sense of how long that's going to go through? Or is it just you just have to wait and see what they do?
Thank you for asking that question. I didn't fully answer when I think George asked it before. So on that customer were angry regular beta what they're trying to do and they really will describe the third of that as a 2-year project and so this thing was second-year. So our feeling is an emergent we've worked with them and just a scale of what they've done you tend to believe the inventories and they're down players and a put them in my pocket.
They have a heavy fix cost structure and I think walking portfolio management for them. My own opinion actually that comes harder and harder because they got the overhead cost that serves there. And so it's our hope that they'll begin to say they're better off not in any more ground and holding on to what they have and they even tried to weave in a little bit of that part of opening on the strategy. So we're going to wait and kind of see what they conclude on their own on that.
And next we'll go to Gabe Hajde with Wells Fargo Securities.
Bob real quick follow-up if you could it sounds like you broke out the pension expense was $10 million and a little bit more in metal food. Can you give us a breakdown of the other two segments?
Yes sure. The remaining $10 million is expected equally between the closures business and the plastics business.
And that does conclude today's question-and-answer session. Now I'd like to turn the call back over to Tony Allott for any additional comments or closing remarks.
Rate. Thank you, David and thank you all for the call. And we look forward to talking to you about our first quarter 2019 late in April.
And that does conclude today's conference. We thank you for your participation. You may now disconnect.