We forecast a better second half for undervalued share with a narrow moat
What we think of earnings for this undervalued shared.
Mentioned: Amcor PLC (AMC)
We modestly raise our fair value estimate for narrow moat Amcor (ASX: AMC) by 2% to $17.80, on the time value of money. In line with our expectations, first-half fiscal 2024 adjusted earnings before interest and taxes (“EBIT”) of USD 709 million was 6% lower than the previous corresponding period on a constant comparable currency basis.
The key drag on earnings was a 9% decline in volumes. About half of this was due to customer destocking of excess inventory. The remainder was due to weaker end-customer demand as household budgets became stretched by high-interest rates. As a result, households are spending less on discretionary goods and switching to lower-cost or bulk items, which generally have less packaging. Despite this, we expect a stronger second half as destocking abates. Our fiscal 2024 forecast assumes volumes decline mid-single digits, with our earnings forecasts unchanged.
The board declared a quarterly dividend of USD 0.13 per share. ASX-traded chess depositary interests will receive an unfranked quarterly dividend of $0.19 per share. A buyback program is in place to repurchase USD 70 million in shares over fiscal 2024. Shares screen as undervalued, trading at about a 17% discount to our revised fair value estimate.
Our unchanged fiscal 2024 EPS estimate of USD 0.67 remains at the lower end of management’s guidance. Our stronger second-half earnings outlook is underpinned by a mid-single-digit decline in volumes, a low-single-digit increase in pricing, no further costs from the Russian business exit in fiscal 2023, and cost savings from plant closures and other restructuring. The firm has also reduced variable costs in response to lower production, although we expect this to return as demand normalizes.
Volumes were 9% lower across each of the flexibles and rigids segments. In the flexibles segment, which accounts for about 75% of group revenue, the volume decline was driven by the healthcare category in the North American, European, and Asian geographies.
Amcor’s strategy revolves around strategic acquisitions and divestments, market share growth, and investment in capacity and capabilities. We see several merits to its strategy that has led to organic and acquisitive growth, and average annual returns on invested capital of 12% over fiscal years 2019-23, comparing favorably against weighted average cost of capital (“WACC”) of 8%. That is a formula for success.
Amcor has strategically acquired and divested assets to drive long-term growth and enhance returns. Key acquisitions include Alcan Packaging (USD 2 billion) and Ball Plastics Packaging (USD 280 million) in 2010; Alusa (USD 435 million) in 2016; and Bemis (USD 6.8 billion) in 2019. Divestments include its Australasia and Packaging Distribution businesses in 2013 (now known as Orora) for AUD 2 billion.
Market share growth initiatives have seen Amcor deploy capital to extend its leading market positions. Customization, on-site packaging facilities or the building of facilities in close proximity have strengthened existing customer relationships, while offering attractive terms has helped develop new relationships.
These initiatives mean Amcor has developed scale positions in key markets and embedded itself as the market leader in North American and Latin American rigids and flexible packaging, global flexible healthcare packaging and specialty cartons, European flexible packing, and Asian flexible packaging.
Investment in capacity and capability involves Amcor targeting capital expenditure of up to 5% of sales with a focus on expanded production in new or existing markets, product innovation and differentiation, and cost productivity. We see this as a prudent strategy to offset product commoditization and help maintain Amcor’s competitive advantages.
We remain constructive on Amcor’s long-term outlook. While we expect competition among packaging solution companies to remain healthy, we expect Amcor to be able to continue growing market share. Amcor is a scale operator in flexible and rigid packaging with long-standing customers. Scale-driven cost advantages and the demonstrated ability to pass through input costs underpin Amcor’s ROIC-WACC spread, with forecast ROIC to average 13% over the five years to fiscal 2028.
We see a narrow moat protecting Amcor's profitability, with scale and capacity in each of its regions affording the company a cost-competitive advantage relative to the closest scale operator, and the ability to earn attractive economic profits through the cycle. We believe Amcor’s cost advantage is driven primarily through procurement, that is buying in bulk and on better terms, and fractionating fixed costs on large volumes allowing Amcor to aggressively drive down unit product costs and maximize profitability in the highly commoditized packaging products sector.
In its largest segments of Flexibles North America and Flexibles Europe, Amcor operates as the largest plastics packaging manufacturer and is approximately twice the size of the number-two manufacturer in those regions. It is also the largest flexibles manufacturer in Latin America and Asia, the largest rigids manufacturer in North America and Latin America, and the largest global manufacturer of flexibles speciality healthcare and flexibles speciality cartons.
Amcor’s scale position in various markets, global presence, and facility network means it can pool demand and negotiate favorable terms and conditions when purchasing inputs, which form a large portion of manufacturing costs. Overall, Amcor’s flexibles' EBIT margins rank favorably among North America- and Europe-listed plastic-based packaging companies, supporting our narrow moat source from cost advantage.
Amcor’s cost advantage is further supported by its network of manufacturing operations with facilities in close proximity to customer operations and in some cases, integrated directly into key customer’s sites. This operating proximity translates into a logistics cost advantage as it is not economical to transport empty bottles or packaging, which have a low value-to-volume ratio. For example, Amcor operates on-site bottling for various food- and beveragemakers thereby reducing the need to transport liquids to a bottling facility.
Regional scale, procurement advantages, and operating efficiency have enabled Amcor to generate an average return on invested capital (“ROIC”) of 14% over fiscal 2014-23. We expect ROICs to incrementally return to similar levels by fiscal 2028 from an inflation-induced cyclical low, driven by further scale benefits, improved mix to higher-margin products, and increased exposures to higher-margin end markets like healthcare.