Rudi’s View: Amcor – Resilience And Capital Discipline

This story features AMCOR PLC. For more info SHARE ANALYSIS: AMC

By Rudi Filapek-Vandyck, Editor FNArena

The secret, so to speak, was printed prominently in the 2010 Annual Report: Amcor ((AMC)) is well positioned by having a substantial growth opportunity that is not dependent on economic recovery (emphasis mine).

At that time, only a few were genuinely paying attention. So painful remains the memory of Amcor's disaster years among investors and stockbrokers that up to this day many refuse to even reconsider the company as a potential investment option. I know of one stockbroker who persistently shows the palm of his hand while turning away his head whenever someone dares to mention the company's name in his presence.

Most funds managers and stockbrokers are straightforward and honest about it: they missed the Amcor turnaround story and by doing so their clients have missed out on one of the better investment opportunities the Australian share market has had on offer between 2009-2012. Consider this: while the Australian share market in general wasn't going anywhere until mid-2012, Amcor shares continued posting double-digit gains, every year, of which a little less than half stemmed from steady dividends. When the Big Rally announced itself in mid-2012, Amcor shares further extended their market-beating performance.

The table below shows the performance of Amcor shares post 2007 (add circa 5% in non-franked dividends to each year's return). Note also the relatively modest fall in 2008 when margin calls and panic selling had become a daily phenomenon in the share market:

To grasp the essence of what makes "Amcor", and to fully understand its internal dynamics, it's best to think of an international conglomerate. Investors in Australia have in recent times fallen in love with Wesfarmers which is officially an industrial conglomerate combining retail outlets with coal mines, insurances, fertilisers, investment banking and listed warehouse retailing properties, but in practice conglomerate Wesfarmers is predominantly a consumer (retail) oriented story. Most conglomerates ultimately cease to exist as during times of troubles management teams find it too difficult to successfully manage different types of operations that often have little in common, let alone any operational synergies.

In the US, Sara Lee has abandoned tobacco and women's underwear to solely concentrate on food products. In Australia, Mayne Nickless and Pacific Dunlop no longer exist (though spin-offs like Mayne Pharmaceuticals, Cochlear and Ansell still do). Amcor has many conglomerate-alike characteristics, with 300 plants located in 42 countries, producing all kinds of packaging, from metal screw tops to cardboard boxes to PET bottles to transparent films for food and medicines. As stated in the opening paragraph: Amcor too has had its rough times.

The difference is, however, inside Amcor are a lot of natural synergies between divisions and across geographies through common customers and distribution channels. Another difference is that Amcor's problems didn't have much to do with its conglomerate-like character, but more so with the break-neck speed at which acquisitions were being announced and executed at the turn of the century. One journalist wrote at the time: No-one, not even Amcor itself, knows exactly how many businesses have been acquired in years past. Before mid-decade that strategy had come unstuck and Amcor quickly turned from market darling into fallen angel and then it descended further into a grizzly bad memory from the past. One that cost a lot of investors a lot of money.

Warren Buffett once said the trouble with most turnaround stories is they never actually turn around, so what has made the difference for Amcor? By 2005 new management and the Board acknowledged Amcor had lost its way. A restructuring was undertaken with the aim of improving core competencies and shedding underperforming businesses. The program was called "The Way Forward". In 2009 the program's principles were embedded within a new operating model; "The Amcor Way". Then Dame Fortuna smiled upon the company.

Heavily-indebted Rio Tinto was struggling for survival amidst lower commodity prices after having overpaid for the acquisition of Alcan in a bid to fend off suitor BHP Billiton. As Rio Tinto became a forced seller of assets, Amcor snapped up Alcan Packaging for a bottom of the cycle price tag of US$1.948 billion, representing 5.1 times calendar year 2009's profit before interest, tax, depreciation and amortisation (PBITDA). Amcor instantaneously became twice as big but also with (at least) twice as many growth opportunities. Management certainly hasn't disappointed by extracting more synergies than originally suggested, ahead of schedule.

All this allowed the 2010 Annual Report to declare that Amcor had by now become a "substantial growth opportunity", regardless of what happened in the global economy. There are not many companies in the Australian share market that are ever able to make such a bold statement, let alone in the midst of a raging bear market.

It's not all related to Alcan Packaging.

With a geographical reach that is virtually unmatched in Australia (except, maybe, by News Corp) Amcor's worldwide operations are a reflection of what is going on the world; always a problem somewhere despite upside elsewhere. At the same time, with some 85% of products and customers related to the food, beverage, tobacco and healthcare sectors, Amcor's operations have a strong built-in resilience. Note that profit growth and dividend increases in recent years have occurred despite a deep and nasty recession in Europe which just happens to be Amcor's most important market!

The conglomerate-like character has been further emphasised by two very tough years for operations in Australia (just like every other local manufacturer) and management has responded with restructuring and cost cutting. The years ahead should see a jump in profitability for these operations as closures of the Petrie recycled cartonboard mill in Queensland and a plant in Thomastown, Victoria should see a material boost in margins and earnings from 2014 onwards.

Don't also forget Amcor is leveraged to better economic momentum in the US, the group's second largest market, while 65 plants and more than 8,000 workers in 24 Emerging Markets now represent some 19% of total group revenues. Since 2000, sales into emerging markets have grown at a compound rate of 18% per annum. As the average consumer in emerging countries grows wealthier by the day, this underpins an increasing demand for packaging. Amcor is already, according to its own assessment, in possession of an unrivalled footprint across South and Central America, Eastern Europe, Russia and Asia, including India and China.

Amcor's operational diversification is strikingly illustrated in the following chart (thanks to BA-Merrill Lynch):

An additional luxury is that the businesses generate a lot of cash flow and now that the bulk of restructuring and integration of Alcan Packaging is done, management will have plenty of shareholder friendly options available, apart from reducing the company's debt ($3.8bn). The past years already saw a $150m share buyback plus a new dividend policy that should pull future increases in line with profit growth. There should still be plenty of growth potential inside the existing operations as margins remain below competitor's levels. Acquisitions, including Alcan Packaging, typically depress margins, which offers room for improvement.

Acquisitions remain firmly on the agenda. Amcor spent some $920m over the past twelve months but management has declared it will remain a responsible investor. This is not a throw-away statement, given the company's failure in the past. There is an investment hurdle of 20% Return on Funds Employed (ROFE); if no suitable investments can be found, the company will seek to return excess cash to shareholders by way of increased dividends and/or share buy-backs.

Admittedly, the drivers behind larger profits in the years ahead are different for the operations in developed economies where product innovation and cost reduction remain key ingredients, while growth will be easier to obtain in emerging markets.

Is there nothing that can disrupt this forecast?

Oh yes, there is. In fact, there's plenty! And outside control of Amcor's management too. With 85% of all profits generated in foreign currencies, predominantly euro and USD, currency fluctuations can have a significant impact for Australian shareholders. Amcor estimates that every euro 1c move impacts net profit by A$5m and every US1c move impacts net profit by A$3m. The good news is, of course, that in case of AUD weakness, Amcor will be a major beneficiary.

As a global manufacturer, rising input costs are always a threat as any pass-ons to customers happen with a delay. Raw materials are typically 30% to 60% of the total cost of production. Important thus. The largest categories of raw materials for Amcor are resins, resin-based films, aluminium, cartonboard and inks.

Another negative is that Amcor's Price-Earnings (PE) ratio has now risen to the upper level of its historical PE range (see chart below). Investors not yet on board might want to wait for share price weakness or to buy on dips in order to avoid disappointing returns in the short term.

In summary: Amcor's All-Weather^(*) characteristics which include resilient revenues, pricing power and a wide geographical and product diversification are at this point in time complemented with several drivers that should ensure strong growth lies ahead. These profit-drivers include recent acquisitions, growth in emerging markets, cost reductions, and ongoing operational improvement. Virtually every analyst covering the stock acknowledges there's plenty of room for unaccounted positive surprises, regardless of further acquisitions. Amcor may well be cruising towards an operational sweet spot in the years ahead.

Ignoring any further upside potential, below are present projections on the basis of FNArena's consensus estimates:

In 2012, Amcor launched a new program "Journey to Greatness" with management explicitly stating: "The objective is to deliver consistent improvement in returns to shareholders, measured as growth in earnings per share and increases in the dividend."

Investors should always consider weaknesses and strengths when assessing investment opportunities. In the case of Amcor, I believe these are:

Weaknesses: – currency fluctuations can heavily impact on profits for Australian shareholders – so can rising input costs were commodities to experience another bull market – acquisitions remain firmly on the agenda and they come with specific risks – Amcor carries $3.8bn in debt which will create headwinds from the moment interest rates start rising

Strengths: – fast growing emerging markets on top of a resilient customer base in developed economies – Amcor aims for top three positions in all markets in which it operates which should guarantee pricing power – multiple profit drivers in years ahead – excess cash virtually guaranteed (which can also turn into a negative in case of mishandling by management)

Bottom Line: shareholders should continue to enjoy growth in the years ahead, while positive surprises in markets like the US, Europe and/or Australia will only add extras to the upside potential.
 

Trivia: Amcor's annual sales four years after the purchase of Alcan Packaging are still below the implied $14bn at the time of the acquisition, but its profits are much higher and so are dividends for shareholders, showing the success of successive restructurings and operational improvements put in place by management over the years.

^(*) Amcor was nominated an All-Weather Performer in my recent eBooklet "Making Risk Your Friend. Finding All-Weather Performers". This eBooklet was published earlier this year and has been made exclusively available to paying subscribers of FNArena (6 and 12 months).

This is the third in a series of analyses on individual companies. Previous stories:

– Rudi's View: CommBank, The Most Consistent, Reliable Performer (14 December 2012)

– Rudi's View: Newcrest's Production Ace (25 October 2012)

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)  

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