-Venezuela an intermittent contributor
-Gains in flexibles in the medium term
-Acquisition strategy intact
-Yet will the Venezuelan effect spread?
 

By Eva Brocklehurst

A write-down of Venezuelan operations has divided brokers in their outlook on Amcor ((AMC)). The company announced the US$350m write-down would be taken in the FY16 accounts, blamed on issues with foreign currency and an increasingly volatile operating environment.

Amcor expects a minimal contribution from Venezuela to earnings in FY17. The company has countered the negative headline on Venezuela with a restructuring of its flexibles division amid plans to streamline operations and cut costs.

UBS dismisses the announcement regarding Venezuela as isolated and an extreme circumstance. Earnings estimates are lowered by 4% for FY17 as a result, which is partly offset by cost cutting initiatives for the flexibles division.

On a broader horizon, the broker believes the acceleration in the company's pace of acquisitions in FY16 is a sign Amcor recognises the need to offset weak underlying growth. The US$10bn Americas market is considered the logical avenue to take, given the fragmented industry and the company's under-representation in the region.

Deteriorating economic conditions in Venezuela mean it is increasingly difficult for Amcor to obtain US dollars and purchase raw materials on a consistent basis. The operations consist of six rigid plastics plants that generate 4% of group revenue. Ord Minnett observes this reality has meant only intermittent production at the facilities in the country.

The one-off charge relates to accumulated FX translation losses and a write off of the net asset position. Amcor has moved to mitigate earnings volatility by adopting a floating exchange rate. On a profit basis, the projected headwind to further earnings is US$20m.

Meanwhile in flexibles, the company is rationalising its manufacturing, reducing complexity and improving speed to market. The company will recognise cash costs of US$120-150m to rationalise the footprint and expects a 35% return on the investment by FY19.

Morgans takes a dimmer view of the developments in Venezuela, doubly downgrading the stock to Reduce from Add. Amcor is still envisaged as a high quality defensive concern with strong management and solid long-term growth opportunities but the broker suspects the problems in Venezuela will ignite concerns around emerging markets.

The company's track record may be excellent in that regard but Morgans does not envisage a positive catalyst on the horizon, suspecting the stock may come under pressure in the short term.

Venezuela is only a minor negative, in Deutsche Bank's opinion. The broker does not expect a material impact on either the balance sheet or dividends, nor does it expect this to significantly impede Amcor's ability to re-invest or undertake acquisitions. Hence, a Hold rating is maintained.

Macquarie sticks by an Outperform rating, also believing Venezuela is a special and isolated case given unusual FX controls. The broker remains comfortable with the company's broader Latin American business, highlighting the larger opportunity post the acquisition of Alusa.

The broker also believes the restructuring initiative in Europe is positively directed towards margin and earnings growth. While acknowledging Europe has low-growth markets in the western sector, there are some initiatives with promise, Macquarie notes, including the shift in equipment to lower cost and higher growth regions in the east.

The broker observes pull-backs in the share price have traditionally provided attractive entry points in the last few years and does not consider this time the situation is much different. Morgan Stanley begs to differ, suspecting there is an increased risk in the emerging markets business.

Challenges across Amcor's business are considered broader than just Venezuela. While restructuring gains in flexibles are expected down the track, the broker suspects, in the near term, this could negatively affect profit by 12% in FY16 and 8% in FY17. Morgan Stanley continues to believe the underlying risks are greater than the market appreciates and the stock should be trading at a lower multiple as a result. Underweight retained.

CLSA maintains the market over-reacted to the news, with around $1bn wiped off the market cap in a single session. Management's efforts to better align its footprint and lower the cost base are lauded, given the low growth environment. Moreover, the leadership position in flexibles should ensure the business is nimble enough to make the adjustments.

CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, is encouraging investors to take advantage of the sell-off, highlighting the ability to deliver consistency on a 10-15% total shareholder return basis and reiterating a Buy rating and $18.15 target.

Credit Suisse, too, is unswayed by the news , despite noting that Amcor is probably bringing in around US$100m in resin into Venezuela and, to the extent the company cannot convert Venezuelan bolivars into US dollars, there is the risk of an accumulation of bolivar working capital. This could produce further devaluation. Hence, there is an ongoing risk to manufacturing in the country.

On the flexibles restructuring, the broker highlights the 35% return expected is significant and far above Amcor's usual investment hurdle of 20%. 

The consensus target for Amcor on the FNArena database is $14.98, suggesting 2.7% in upside to the last share price. Ahead of the news this was $15.44. Targets range from $12.07 (Morgan Stanley) to $17.50 (Macquarie). There are two Buy ratings, four Hold and two Sell.

See also, Brokers Forgive Amcor Acquisition on April 19 2016.
 

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-Poor outlook for phosphate market
-Louisiana on track for end 2016
-Signals potential capital return
 

By Eva Brocklehurst

Incitec Pivot ((IPL)) surprised most brokers with its first half results, as the impact on earnings from the Dyno Nobel Americas volume losses in the coal and metals markets was less than expected. Moreover, the company impressed with record production from its Australian Moranbah and Phosphate Hill plants.

Even with the low-quality items, such as stock elimination and lower net interest, taken out of the equation the first half was stronger than Morgans expected. This is due to an impressive result from Moranbah and the North American explosives outcome. A clear tailwind is the lower Australian dollar, although the broker concedes this will diminish in the second half, given the material decline has now been cycled.

The broker welcomes the new efficiency program that is expected to deliver $80m in cost savings and $20m in capex savings by the end of FY17. FY16 may be a challenging year but Morgans expects earnings growth to return in FY17, as the Louisiana ammonia plant ramps up. Based on the broker's forecasts the stock is trading in line with its global peers.

No formal earnings guidance was provided, and given the uncertainties, the company's outlook comments were the lightest in years, Morgans adds. The potential for further declines in coal volumes in the US and pressure on Australian coal markets was flagged, as well as lower fertiliser prices. All up, the broker remains a happy holder of the stock.

Approximately half of the lost volume in the US market appears to reflect underperforming contracts, from which the company decided to walk away. This is validated, Credit Suisse maintains, given the average margin loss was only US$46/t. Hence, the impact on the bottom line is less severe.

Credit Suisse observes cost reductions have accelerated, to help offset more difficult market conditions. On the other hand, the outlook for phosphate markets is considered poor and no recovery in di-ammonium phosphate (DAP) prices is expected until FY19. Still, the broker forecasts $420m in free cash flow in FY17 and FY18 and allocates $240m to capital management in each of those years.

Morgan Stanley considers the results messy, significantly affected by the decision to impair Gibson Island, raising the prospect the plant could be loss making from September 2018. Nevertheless, underlying earnings beat this broker's estimates as well.

On a deeper level, Morgan Stanley notes that this was entirely driven by a $32m favourable movement in stock clearance and, without it, earnings would have missed forecasts by 9.0%. The broker surmises that this benefit will disappear in the second half and, given the headwinds, consensus earnings estimates for FY16 may need to fall by as much as 10%.

What is most important is that the Louisiana plant is on track, Macquarie asserts. The project is now 97% complete and on budget. The write down of Gibson Island was not a surprise, given the prohibitive gas costs currently on offer and Macquarie, having phased down profit estimates in FY19/20, now reduces this to zero.

 A solid balance sheet and capital management potential has been reiterated and the explosives business appears resilient, leaving the broker with a positive outlook.

Ord Minnett is of a similar view, given the challenging markets, and believes the company has executed well on the variables within its control. Phosphate Hill and Moranbah are producing at record levels and explosives margins for Dyno Nobel Americas have improved as a result of efficiencies.

Deutsche Bank raises earnings forecasts by 6-12% to reflect higher Southern Cross and Australian explosives earnings as well as lower net interest expenses, partly offset by lower US explosives earnings.

The broker flags the benefit from recent rainfall on the east coast of Australia for fertiliser consumption and for North American quarry & construction (Q&C) volumes, with the passage through the US Congress of the 5-year US$305bn highway bill. The company expects Q&C volumes to increases by 1-2% plus GDP per annum over the next five years.

The broker notes the company is seeking to return capital upon production being deemed reliable at Louisiana, the timing of which is expected to be late 2016 early 2017.

UBS found the results credible, given the challenges, and raises earnings estimates by 13% for FY16 and 8.0% for FY17. The highlight was the explosives businesses in Australia, which indicates the favourable position that Moranbah has in the market, and in North America, where the Dyno explosives earnings fell just 4.0% despite an 18% drop in volumes, led by significant declines in coal-related ammonium nitrate demand.

This result demonstrates to UBS a focus on costs but also the company's limited earnings exposure to US coal end-markets, which are estimated to make up less than 10% of group earnings exposure from FY17. The stock is screening as good value to the broker, despite forecasts being struck off trough fertiliser price assumptions in FY17.

FNArena's database shows six Buy ratings, one Hold (Morgans) and one Sell (Morgan Stanley). The consensus target is $3.69, suggesting 14.7% upside to the last share price. Targets range from $2.71 (Morgan Stanley) to $4.80 (Deutsche Bank).
 

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-Are structural headwinds persisting?
-More downside potential to earnings
-Dividend cut suggests stock expensive
 

By Eva Brocklehurst

The challenges continue for explosives business Orica ((ORI)), which reported a soft first half and has retreated from its prior guidance of FY16 being an improvement on FY15. The company has also cut its dividend. Earnings in the first half were affected by price reductions in Australia and a decline in ammonium nitrate (AN) volumes in the coal markets of both Australia and North America.

The share price suffered substantially. Unnecessarily so, Credit Suisse contends. The result was 5% below the broker's forecasts and, while expecting FY16 earnings to be down 6%, the broker notes capital discipline has improved. Credit Suisse does not believe the stock warrants a Buy case, retaining a Neutral rating, but there is a sustainable level of profit around current levels. Hence, some value needs to be accorded the stock.

Furthermore, a duopoly situation in Australia – shared with Incitec Pivot ((IPL)) - is not conducive to long-term sub-economic outcomes in the broker's opinion. The US market has overshot on the downside, Credit Suisse suspects, and there is some recovery in volumes likely in FY17. Meanwhile, quarry and construction markets offer growth.

Citi sticks with a Buy rating, taking the view that this is the low point in the present cycle, or very close to it, and the company is better positioned than it has been in the past. Deutsche Bank is of similar disposition, suggesting capex reductions have meant the company has achieved its business improvement target.

Nonetheless, the decision to cease guiding for growth and reduce the dividend is a sign the company is facing structural headwinds, Morgan Stanley asserts. The broker believes the company needs AN volumes to grow as it cannot cut costs fast enough to offset the downturn. The broker continues to expect material downside for the stock and believes consensus estimates need to fall by more than 10%, with even larger reductions for FY17.

Earnings in the first half were 4.9% below Ord Minnett's forecasts and the downgrade to the outlook larger than expected. The broker reduces earnings estimates by an average of 15% over the next three years, noting no guidance was provided on the magnitude of the earnings impact in the second half from the reduced volumes, which suggest a decline of 8.5%, an omission which puzzles Credit Suisse as well.

There are other areas of uncertainty prevailing, with the Burrup (Pilbara) AN plant enduring losses as it ramps up to production by the end of the year and question marks over the displacing of Bontang (Indonesia) volumes as Burrup comes on line.

The interim dividend of 20.5c is well below Macquarie's forecast of 39c, and reflects a new policy with a 40-70% pay-out ratio. The broker was surprised by the reduction, suggesting the balance sheet appears less robust than foreseen. While the broker believes the metrics are alright, at 43% gearing, a move down to BBB-minus from BBB in terms of credit rating would mean a material lift in interest costs and less private placement liquidity.

The lower capex outlook for FY16, whilst a positive, is not expected to be enough to preserve the dividend. Macquarie reiterates a belief that the downgrade cycle is always longer and deeper than expected and, while Orica is doing what it can in terms of self help, it continues to be overwhelmed by negative price and volume trends.

On the positive side, the broker highlights an extended and expanded contract for AN supply to Fortescue Metals ((FMG)). Fortescue is the largest customer of the Burrup expansion. Orica has also won 100% of its contract renewals in Australia, Asia, Europe and Africa in the first half.

Morgans expected guidance to be downgraded for FY16 and the first half was better than feared, because of lower depreciation costs and $13m in asset sales. In light of the market conditions the broker believes the company is doing the best it can to take costs out of the business, increasing manufacturing efficiency and reducing debt. Free cash flow should improve as capex requirements will fall following the commissioning of Burrup. Morgans expects volume growth will return to the Australian market in FY17 but still urges caution.

While the company believes most of the re-pricing has taken effect, UBS suspects downside risks exist for AN pricing beyond the current year. Excess supply is a headwind, alongside weaker demand in the company’s largest markets of Australia and North America. The broker expects this to get worse as new manufacturing capacity is added in both regions.

Despite the re-basing of earnings expectations after the result, UBS retains a Sell rating. The cut to dividends makes the stock look expensive on the broker's calculations, with no earnings growth expected over the next three years.

FNArena's database shows two Buy ratings, three Hold and three Sell. The consensus target is $13.25, suggesting 4.1% downside to the last share price. This compares with $15.51 ahead of the results. Targets range from $11.32 (Morgan Stanley) to $14.60 (Ord Minnett).

See also, Orica Hesitates, But Earnings Downgrade Likely on February 1 2016.
 

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-Immediate scale in key LatAm market
-Synergies with existing business
-Sales in defensive end markets
 

By Eva Brocklehurst

Amcor ((AMC)) will acquire Alusa, a manufacturer of flexible packaging in South America, for US$435m, a transaction welcomed by most brokers as it provides a strong regional presence which will complement Amcor's existing business.

Amcor expects to realise a 15% return on investment (ROI) target by year three and 20% by year five. The longer path to Amcor's previous ROI benchmark - 20% by year three - is considered largely justified by Alusa's market position.

Ord Minnett expects the transaction to be around 2-5% accretive in the first three years. The broker does not consider the additional two years to the ROI target a major issue, given the company's strong track record in delivering value-accretive acquisitions. Moreover, Alusa offers immediate scale in South America and Amcor avoids having to consolidate several smaller entities over a longer time frame to achieve equivalent scale.

Alusa currently generates revenue of around US$375m per annum which means, in combination with Amcor's US$100m in flexibles sales in the region, the combined group holds 10% share of the addressable end market. Ord Minnett suspects this will provide a solid foundation for smaller, bolt-on acquisitions in the future.

Deutsche Bank also considers the acquisition is justified at a lower return as it provides an additional platform to grow in Amcor's preferred markets. Having created the Flexible Americas business in July 2015, Amcor has almost doubled its sales projections to US$1bn with this acquisition, the broker notes.

The Alusa business services multinational and large regional customers across the food, personal care and pet food segments. Its capabilities include film extrusion, flexo, gravure printing and lamination. Amcor is targeting synergies of US$25m by year three across procurement and manufacturing.

While the return profile is more extended, the company's track record recommends the transaction to Macquarie. There is also enough margin for value creation, the broker adds.

Of interest, Macquarie notes the average working capital of Alusa is double Amcor's flexibles average, which should entail material working capital release. The broker estimates this represents up to $30-40m in potential savings and, while it take time to be realised, adds 125 basis points to the return from the acquisition.

UBS also excuses the lower rate return, given the scale. Sales are mostly derived from defensive end markets, with food making up around 65% of revenue and personal care accounting for the remainder. Moreover, UBS notes around 40% of Alusa's sales are to large multinationals which Amcor mostly counts as customers elsewhere, providing the opportunity for additional revenue synergies.

The acquisition also appeals to Credit Suisse, given it is a quality business that should bring both value and earnings accretion. The broker believes a relaxation of Amcor's acquisition hurdle of 20% is critical if it wants to grow in North America. Achieving critical mass with small bolt-ons would be too hard over a reasonable time frame in Latin America, the broker suggests, let alone in North America.

Morgan Stanley stands apart from other brokers in that it suspects the company has run out of momentum and may find further acquisitions of this type difficult in the near term.

The broker notes this is the most sizeable transaction since the company's Alcan acquisition in 2010 yet, despite significant capital allocation, the transaction is likely be broadly neutral to FY17 earnings estimates and 2.0% accretive in FY18. Morgan Stanley considers the stock overvalued, retaining an Underweight rating.

Alusa has production facilities in Chile, Argentina, Peru and Columbia and supplies all other countries in the region. The current owner, Chile-listed Techpack, requires shareholder and regulatory approvals on the sale and Amcor expects the deal to be completed in coming months.

Hence, Morgans makes no adjustments to earnings forecast at this stage but will review estimates once the deal is finalised. Still, the broker considers Amcor deserves to trade at a premium given its stable and defensive growth profile and superior financial returns relative to the market.

The size of the South American flexibles market is considered to be US$4.8bn, growing at 3-4.0% per annum. Deutsche Bank notes there is a similar sized competitor, but without the geographical reach, while the number three player is half the size of Alusa.

The consensus target on the FNArena database is $14.77, suggesting 3.5% downside to the last share price. This compares with $14.32 ahead of the news. Targets range from $12.07 (Morgan Stanley) to $16.50 (Macquarie). The database has four Buy ratings, three Hold and one Sell (Morgan Stanley).
 

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-Several drivers underpin the stock
-Valuation too rich?
-Plans to increase gross margins
 

By Eva Brocklehurst

Automotive aftermarket parts is a steadily growing market, driven by rising numbers of vehicles in Australia. Burson Group ((BAP)) is well placed to take advantage of this market, having acquired Aftermarket Network Australia last year, expanding its coverage of wholesale, retail and chain workshops.

Macquarie takes up coverage of the stock with an Outperform rating and $5.03 target, citing several growth drivers for the industry including population and demand growth as well as the increasing value of parts.

Another driver of the automotive aftermarket parts is the age mix of the Australian vehicle fleet. This is important, the broker contends, as most aftermarket parts are used to service vehicles that are over four years old. Average growth in vehicles over five years old has been 2.0% over the most recent decade, the broker observes, with the proportion of the fleet over this age rising to 69%.

Increasingly, vehicle complexity has also made it more difficult for the do-it-yourself owners to service, and complexity of parts makes it easier and cost effective to replace rather than repair them. Macquarie expects this trend to persist, with younger people less keen or able to repair their own vehicles.

While there are no statistics for automotive aftermarket part prices, there is evidence that locally manufactured prices of parts grew 10% in 2015 largely, in the broker's view, because of the depreciation in the Australian dollar and the impact on imported prices.

The broker does caution against relying too heavily on these prices as the vast majority of parts are imported into Australia. Pricing of parts is generally viewed as a non-discretionary component of a workshop invoice and passed onto the consumer by both the distributor and workshop.

Morgans also observes the company has clear view on where its sources of growth will be over the next five years, and considers Burson's presence across the supply chain augurs well for success.

Macquarie concedes the stock's valuation appears rich but observes two precedents: valuations achieved by early stage roll-out stories, which have consistently traded at a price/earnings (PE) ratio of 20-25, and international peers that are trading at PEs as high as 23 times 2017 earnings forecasts. Burson deserves to trade at a premium to its peers, Macquarie maintains, given its FY13-17 forecast compound earning growth rate of 27.1%.

Growth is expected to decelerate in FY18 and beyond but the company should still grow faster than Macquarie estimates for its small industrials coverage. The company's strategy is given the thumbs up from Morgan Stanley too, with the broker believing the stock deserves a premium rating.

There are a number of issues and challenges for the market but Macquarie finds none of these are pressing. The demise of Australian vehicle manufacturing is unlikely to affect the number of vehicles in Australia or the parts market.

There are strategies by manufacturers to tie the vehicle to its original service centre for a longer period via extended warranties and fixed price servicing but, as the automotive aftermarket is generally looking after vehicles more than four years old, this is not expected to impact demand.

The impact of electric or driver-less cars is considered an event well into the future, although it could create more of a issue for the aftermarket. Macquarie notes the fact that electric cars may require fewer parts is yet to be proven.

Burson generated FY15 pro forma revenue of $620m. The original business operates in the trade distribution part of the value chain through its 136-store network, located in all states except Western Australia. The company has a target for store numbers of 200. The two distribution centres are located in Brisbane and Melbourne.

The company generates 80% of sales through parts delivery to workshops with the balance from in-store sales to do-it-yourself customers. Aftermarket Network Australia expanded Burson's coverage with an additional 471 outlets. The wholesale business has 10 distribution centres servicing over 3,000 independent customers.

Macquarie does note that Burson, while successful in increasing gross margins over time, is not yet at the same margin as rival Repco. The broker believes this is due to a higher proportion of retail sales in the Repco business, estimating Repco is close to 50% retail while Burson is less than 20%.

Burson intends to expand gross margins by increasing the proportion of sales from private label and increasing the proportion of directly sourced parts. Macquarie notes the Aftermarket Network acquisition represents a material opportunity to increase both these components.

FNArena's database shows three Buy ratings and one Hold (UBS). The consensus target is $4.97, suggesting 4.7% upside to the last share price.
 

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