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Model Portfolio | Is inflation starting to bite?

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Analyst: Spiro Courtis ,
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    With cashflow certainty from defensive sectors, AMC’s valuation is attractive, currently 50% below the ASX Industrials (ex-Financials) index. Offering a 4% dividend yield and low volatility makes this stock scarce and highly desirable. 

    Ever so reliable, performance wise, long term total return has averaged 10-15%p.a. This is set to continue with Earnings per share (EPS) growth guidance for FY22 set at 7-11%. 

    With a high-Income yield and low volatility, the stock is a firm holding across multiple Clime portfolios and will remain so given its significant market share and defensive qualities. 

Amcor recently announced price increases of up to 15% for products across its global businesses effective from 1 January 2022. This is a response to supply constraints and higher input costs across multiple categories including raw materials, transport, and energy which have been increasing since the beginning of this calendar year. AMC’s packaging products are essential and as such are largely price inelastic. This allows the company to pass on costs to its customers to protect margins. 

 

Plastic packaging uses a raw material called polyethylene resin which is largely derived from hydrocarbons stored in petroleum and natural gas. North America’s low-density polyethylene (LDPE) pricing is relevant as the company generates approximately 50% of its revenue in North America and is used for flexible packaging such as plastic bags, food packaging, wraps, and films. The company derives about 84% of its earnings before income tax (EBIT) from flexible packaging and the balance from rigid packaging, polyethylene terephthalate (PET). AMC generates about 30% of its revenue from Europe making local LDPE prices also relevant. Prices have risen by up to 80% as shown in figure 2. Resin price increases appear to have stabilized, therefore reducing the risk of inflation headwinds for packaging companies. 

Figure 1 – US polyethylene resin prices 

 

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Source: Bloomberg, Morgan Stanley Research 

 

Figure 2 – Europe polyethylene resin prices 

 

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Source: Bloomberg, Morgan Stanley Research 

 

It is important to note that AMC has pass-through mechanisms in place to manage inflation in its input costs. In the rigids segment of the business, pricing is based on 30-day contracts resulting in quick price pass-throughs while in flexibles, prices are typically reset quarterly with resin prices accounting for about 60% of flexibles raw material spend. 

 

Despite cost pressures, in its recent 1Q22, November results notice, AMC delivered a typical, dependable result given its highly defensive exposures, including a low double-digit EPS growth of 12% (US17.7cps), a 4% dividend yield, and US$400m active buyback all adding to the appeal this company has to the average investor. Group EBIT of US$381m was +7% versus the prior comparable period with flexibles EBIT of US$339m up 8.6% and rigids down 14% (US$62m). 

AMC is largely an essential services business providing packaging to multiple discretionary and non-discretionary sectors of the world economy. With the market uncertainty continuing to gather pace, further complicated by the onset of the new COVID-19 variant Omicron, AMC should be able to continue to provide cash flow certainty despite elevated market volatility and widespread raw material and supply chain pressures. Group revenues for the quarter increased by 10% but only by 1% on a comparable constant currency basis. The company maintained its FY22 guidance for constant currency EPS growth of 7-11%, adjusted free cash flow of US$1.1-1.2bn, and the buyback of US$400m to be maintained.  

With AMC trading at an FY22 expected price to earnings (P/E) of 15x, the stock represents great value relative to the ASX200 Industrials (ex-Financials) index, currently 50% below the index, with a 5-year average of 70% relative to the index.  

Figure 3: AMC P/E versus the ASX200 Industrials (ex-Financials) index 

 

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Source: Refinitiv, Morgan Stanley Research 

 

The essential nature of AMC’s consumer and healthcare end markets means the year-to-year volatility is relatively low, currently tracking at 16% on an annual basis which compares to the ASX200 volatility of around 11%. AMC has a global footprint with leadership positions in every major geographic region. Following on from the 2019 acquisition of Bemis, AMC is well on its way to being a leading global packaging company. Bemis synergy benefits are expected to exceed the original $180m three-year target by at least 10%.  

 

During the previous financial year, both the flexibles and rigids packaging segments contributed to margins expanding by 12.6% despite supply chain concerns and steep raw material cost increases. This is attributable to the inflation pass-through mechanisms mentioned earlier, other cost control measuresorganic growth in the base business, and disciplined margin management. 

 

This proves the resilience of the business as over time it has successfully generated strong and consistent value creation for shareholders by a combination of dividends, organic growth, and using free cash flow to pursue targeted acquisitions such as Beamis or returning cash to shareholders via share buybacks. Having returned a total of US$1bn in cash to shareholders during FY21, Amcor provided a total return of 21% which exceeded their long-term average of 10-15% per year, including a 4% dividend yield paid quarterly (see figure 4 below) which has grown at a CAGR of ~4.6%p.a since listing. 

 

Figure 4 – AMC dividend per share  

 

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Source: Factset 

 

With continued demand from consumers for more sustainable, responsible packaging, AMC sees research and development in this area presenting a substantial growth opportunity. The company recently announced plans to construct two innovation centers in Asia and Europe as well as a new partnership with Michigan State University’s school of packaging, typically spending US$100m annually in Research and Development. Focused on making packaging increasingly lightweight, recyclable, and reusable, and over the last two years, AMC has achieved a doubling in the use of recycled resin (used in rigidwhile expecting this to double again over the next 12-18 monthsThe company has commercialised several recycle-ready platforms including the polymer-based AmLite and AmPrima and paper-based Matrix product ranges. It is expecting new partnerships to scale up and extend these compostable solutions resulting in a future growth opportunity for the company. AMC is aligned with the US and ANZPAC plastic pacts and 4evergreen alliance in Europe which aim to implement solutions towards a circular economy. This year Amcor joined the Alliance to End Plastic Waste, which is committed to keeping packaging out of the environment after it has been used. 

 

 

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No trades were conducted this week.  

 

The Clime team wishes all subscribers a very Merry Christmas and a Happier New Year. 

 

 

 

 

Ownership Disclosures: 
Our fund partner Clime Asset Management (Clime) owns (AMC) on behalf of various mandates where it acts as an investment manager.

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