Amcor Gets Diversifed

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Packaging container business Amcor has increased its diversified products exposure, prompting mixed responses from brokers.

-Projected returns below the company's stated targets by FY20
-Is Amcor investing its way out of potential challenges?
-Deal expected to enhance scale, capabilities and product
 

By Eva Brocklehurst

Packaging container business Amcor ((AMC)) is taking the bull by the horns when it comes to acquisitions, with the latest being Sonoco's North American rigid plastics moulding business for US$280m. Including synergies, pre-tax profit is expected to be US$50m after the third full year of ownership.

This business comprises six production sites in the US and one in Canada. Two thirds of the operations in North America are leveraged to polypropylene and polyethylene products and the balance to PET plastic. Nevertheless, brokers calculate that by year three (FY20) pre-tax returns from the business will reach around 17%, which is below Amcor's stated target of return on funds employed (ROFE) of 20%.

Ord Minnett defends the target as only including cost synergies, and flags the opportunities that exist to cross-sell the new speciality container products to existing customers of Amcor, and across geographies, which could help push returns towards 20% beyond FY20. The company will also breach its debt leverage range but Ord Minnett considers this a temporary issue.

Morgan Stanley differs, suspecting the aggressive actions from the company mean there could be underlying challenges to its targets. The broker suggests Amcor may feel an urgent need to invest its way out of potential challenges. The broker accepts the acquisition provides more evidence of the company's ability to supplement growth by drawing on the strength of its cash flow and capacity to gear up the balance sheet.

While the purchase may make strategic sense, from a pure financial perspective Morgan Stanley finds the deal less than compelling. Projected returns are below the three-year hurdle from this deal and in the last six months Amcor has announced a total of US$935m in acquisitions and a US$200m restructuring, which the broker believes signals an aggressive shift in growth capital allocation. Hence, conditions may be getting tougher, and thus require a shift in behaviour to reach pre-established targets for value creation.

Deutsche Bank does not have the same misgivings and raises its rating to Buy from Hold as the stock is now trading at a 9% discount to the broker's revised valuation. The broker estimates the dividend yield in FY17 at 3.8% and free cash flow yield at 5.1%. The acquisition is expected to be complementary to the existing business and enhance the scale, capabilities and product platform for Amcor.

The acquisition has particular strengths in extrusion blow moulding, multi-layering and decorating and, as with Ord Minnett, Deutsche Bank notes there are opportunities across procurement, and operational improvements to be had in the manufacturing footprint. Deutsche Bank expects strong earnings growth for the next 2-3 years, with benefits to come from acquisitions and the flexibles restructuring initiatives.

Citi upgrades to Buy from Neutral as well, because of the much-needed scale the acquisition provides for Amcor's diversified products divisions. Credit Suisse also views the acquisition in a similar light, as the company's diversified products business now has US$750m in sales, of which 90% is in North America and 10% in South America.

The acquisition increases Amcor's exposure and capability in plastic resins other than PET. While net debt is likely to exceed the range of 2.25-2.75 times EBITDA in the first half, Credit Suisse estimates de-leveraging to around 2.1 times by FY20, and concludes that achieving the 20% ROFE target by FY20 is not unrealistic.

The broker also notes the procurement and footprint savings – there is a geographical overlap in manufacturing capacity – are not only in terms of the Sonoco business but will also aid Amcor's nascent diversified product operations. For example, a large amount of procurement involves the purchase of polyethylene and polypropylene where Amcor is only buying small volumes currently.

Macquarie considers Amcor has confirmed its defensiveness at the recent results and management is well able to navigate the subdued operating environment. The broker believes the stock deserves to trade at a premium to its global peers given its track record of delivery and superior returns, free cash flow and dividend profile.

FNArena's database shows four Buy, three Hold and one Sell (Morgan Stanley). The consensus target is $16.38, suggesting 0.8% upside to the last share price. Targets range from $12.20 (Morgan Stanley) to $17.95 (Citi).
 

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