Amcor Analysis

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Amcor Analysis
Amcor Analysis (ASX:AMC)
Amcor is a global packaging company with operations in Australasia, Asia, North America, South America and Europe.  It produces flexible and rigid packaging.  Along with being the largest PET bottle producer in the world, Amcor also produces packaging for food, pharmaceuticals, beverages, tobacco products and more.

Quality
Amcor is a good quality company with a market capitalization of approximately $16 billion AUD.  The reasons for Amcor’s quality are as follows:

1.  The company has a major competitive advantage in its size. The sunk costs are enormous.  A competitor would need deep pockets to develop plant capabilities to compete with Amcor.

2.  Amcor is a defensive business. The bottom of economic cycles can devastate some businesses that appear to be good businesses through most of the cycle – think banking.  The packaging of consumables is relatively resistant to economic cycles and demand remains relatively constant.  However, Amcor does have approximately $4.5 billion USD of net debt and it should be noted that in a severe downturn debt funding and rollover options will come with more stringent conditions.

3.  Many of Amcor’s plants are heavily automated and along with sunk costs a certain amount of intellectual capital is employed to build efficient plants on this scale. Sure, a competitor could build a smaller plant using a company such as Automation and Packaging and obtain any number of good, off the shelf units, but Amcor is on a completely different scale.

Valuation (all values in USD)
Amcor’s valuation does not look overly demanding in a relatively expensive market.
Approximate values below are my estimates for FY18:
EV = $17 billion
Market cap = $12.5 billion
Cash flow before working capital provisions = $1.3-$1.4 billion
Profit = $600 – $700 million
EBIT = 1 billion
EV/EBIT = 17
FCF yield = 4.5% (I have assumed $150 million p.a. to keep plant and equipment up to date)

Assuming no price deflation Amcor can continue to increase profit margins.  The decrease in employee costs is likely to continue as the increased automation trend continues.

Summation of the above leads to the conclusion that Amcor is moderately undervalued.  An assumption of a 9-10% p.a. return over the long term seems reasonable.  The return would consist of a 4% dividend, 2-3% product inflation and 3-4% through productivity improvements and cost reductions.

Competitors
Amcor doesn’t tend to compete with Crown Holdings, Owens-Illinois or Ardagh Group directly as they are more associated with metal and glass containers, as opposed to PET bottles.  Though some overlap in demand between these products does exist.  Ball Corp is another heavy weight in this industry and not only does it produce metal containers, it does have some overlap in the plastic bottle industry after its recent acquisition of Rexam PLC.  Silgan Holdings, West Rock and Beamis all have some overlap in the flexibles division.

The competitive environment is tempered by geographical isolation and being a high volume low cost item packaging tends to be sourced nearby much of the time.  Recent annual reports from Amcor seem to indicate the flexibles competitive environment remains rather benign and cost increases/efficiency drives have been able to increase profits on this side of the business.  The rigid packaging, ie. PET bottles has been facing more competitive pressure and this is one part of the business that remains a concern.  Though it should be noted most of Amcor’s business is in the flexibles division.

The growth in earnings of both the competitors above and Amcor can be partially attributed to increasing efficiencies through automation.  However, this alone does not account for the strong earnings growth experienced in this industry over the last few decades.  Indeed, it appears industry dynamics are still in place for pleasing returns on capital.

Summary
Amcor is a good quality company with a high degree of earnings visibility.  This enables investors to have a reasonable degree of confidence in valuing Amcor and an EV/EBITDA valuation model seems reasonable in this case.  Amcor is likely to keep growing at a moderate pace above inflation and currently provides an attractive risk/return profile.

Disclosure: Amcor is held in a portfolio managed by the author of this article.