Shares in Amcor (ASX:AMC) have struggled to recover ground since being de-rated in early 2023. Volume weakness, lower margin, and the lack of a major acquisition since mid-2019 have all weighed on sentiment.
We recently researched AMC in The Dynamic Investor following a better-than-expected result for the three months to 31 March 2024 (3Q24). While the 3Q24 result showed an improvement in volumes, we assess whether this can translate into improved earnings growth.
About Amcor
Amcor is a global packaging manufacturer which has two operating divisions: Flexibles and Rigid Packaging (Rigids). The Flexibles division has operations in North America and South America, Europe and the Asia Pacific region. The Flexibles division includes the Bemis business (acquisition completed in June 2019) and accounts for >80% of group earnings. Key end market exposures are defensive sectors, namely food, healthcare, home & personal and tobacco. The Rigids division is mostly exposed to the beverage and personal care markets in North America and Latin America.
The revenue profile is highly skewed to defensive end markets, in particular the Food, Beverage and Healthcare categories.
Key Fundamental Drivers
Outlook for Volumes Remains Challenging
One of the most encouraging aspects of the 3Q24 result was the sequential improvement in volumes (-4%) vs 2Q24 (-10%). Of the -4% decline in 3Q24 volumes, -2% was due to weakness in underlying consumer demand while the other -2% mainly reflecting ongoing destocking in healthcare and North America beverages. Combined, these two sectors represent ~30% of AMC’s revenue with volumes for the remaining ~70% of revenue flat.
Excluding the Healthcare category, management expects destocking to be largely finished by the end of FY24. There is potential for destocking in the Healthcare category to continue into 1Q25. Notwithstanding, volume softness is expected to continue in 4Q24, with the Company guiding to low single-digit volume declines due to ongoing destocking in healthcare and North American beverages.
The prospects for volume improvement in FY25 are largely dependent on an improvement in several categories impacted by customer destocking. These include North American Beverages and Hot-Fill for the Rigids segment. In particular, volumes in the Healthcare category (within the Flexibles segment) are expected to remain weak, given that Healthcare customers continuing to remain unwilling to rebuild inventories after destocking.
One potential ‘green shoot’ for volumes is that AMC customers are starting to increase promotional activity, which has resulted in a partial flow through to its volumes.
Is Operating Leverage Still Achievable?
While AMC has the potential to benefit from an increase in volumes post cost-out initiatives, we consider that there are risks to the EBIT margin for the Flexibles division in FY25 from several factors:
i. There is a risk that some non-structural cost savings seen in 3Q24 will not flow into FY25 alongside a ramp-up in volumes.
ii. Raw material pricing may impact EBIT margin for the Flexibles division in FY25. To this end, it is worth noting that raw material pricing provided a minor support to the EBIT margin for the Flexibles division in 3Q24. Having said that, raw material prices are not expected to be a material headwind.
iii. The price/mix effect for the group overall is likely to remain negative. This is because the higher-value Healthcare volumes remain under pressure. In addition, inflation remains high/persistent enough to affect demand levels.
Merger & Acquisitions Remain on the Agenda
Given that the Company expects substantial free cashflow in FY24 (guidance is for US$850-950m), Merger & Acquisition opportunities remain a priority, with management comments suggesting that its preferred use of free cash is towards ongoing bolt-on acquisitions.
Balance sheet capacity has reduced as a result of elevated gearing levels and commitment to sustaining capital returns to shareholders. As such, any further acquisitions are likely to be small and bolt-on in nature. Another element is that competition regulators would likely block larger deals which overlap with AMC’s focus segments.
Fundamental View
Amcor is currently trading on a 1-year forward P/E multiple of ~13.5x. This multiple is at the bottom end of the trading range over the past two years and in line with the average multiple of ~14x over the same period. The shares also appear unattractive in the context of a modest EPS growth profile (in US$ terms) of +4.5% over FY24-26 on a CAGR basis.
Any potential upside to the EPS growth profile is likely to be moderate, as it would rely heavily on a recovery in volume, as opposed to EPS-accretive Merger & Acquisitions or share buy-backs. This is due to an elevated gearing position. Further, while solid cost control has helped offset weaker volumes, the realisation of higher EPS growth from stronger volumes may be constrained by persistent consumer price inflation.
Charting View
We looked at the AMC chart on 19 December in The Dynamic Investor and noted “AMC remains in a downtrend, but the past few weeks has seen it rise above some resistance. At best, we may see it move sideways for a few more months to build a base and then we can reassess the chart. A weekly close above $14.65 would start to look more constructive.” After that, it traded sideways to develop the base and then pushed higher at the start of May. It has retested that breakout line and is starting to move higher again. We expect a recovery from here in the share price towards $16 – $16.50. This could either be a short-term trade for those looking to buy now, or an exit level for current holders.
Michael Gable is managing director of Fairmont Equities.
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