Crown Holdings reported third-quarter results that were broadly in line with our expectations, but we have increasing concerns about the profit potential of Crown’s operations in Asia-Pacific. For example, through the first nine months of the year, Asia-Pacific segment profit declined $2 million while sales increased $157 million compared with the first nine months of 2012.

In recent years, the company has invested significant sums in the region to expand can capacity in anticipation of growing middle-class demand in China and Southeast Asia. Certainly some of the margin weakness in Asia-Pacific can be attributed to plant startup costs, but with management’s expectations of needing another two years before China demand catches up with installed industry capacity, it may be three years or more before its recent Asia-Pacific investments, as a group, begin to earn their costs of capital.

Though the segment accounts for only approximately 12% of overall sales and 10% of total operating profit, it accounted for 46% of the company’s capital expenditures over the last two years and is an important part of the company’s long-term growth strategy. When taken into consideration alongside Crown’s high leverage (3.66 times net debt/adjusted EBITDA), there’s a lot riding on Crown’s success in Asia-Pacific.

The best-performing segment this quarter was European Beverage, which posted year-over-year sales growth of 6.7% and company-high operating margins of 17%. Much of the segment’s success this quarter is attributable to a new beverage can plant in Turkey and taking some packaging share from returnable glass in Europe. Management slightly hedged its full-year free cash flow outlook, saying in today’s call that free cash flow would come in at “approximately” $500 million versus “at least” $500 million as communicated in the previous call. After reviewing results, we are maintaining our $40 per share fair value estimate.