Company: Amcor Ltd 

ASX Code: AMC

Share Price: $5.04

Market cap: $4.21bn

Recommendation: ‘Avoid’

The sale of Alcan’s packaging business by current custodian Rio Tinto has ignited interest in potential acquirers, including our own Amcor. Already boasting global packaging operations offering a broad range of plastic, fibre, metal and glass packaging products – a deal with Rio has been touted as a logical move for Amcor. The company’s origins trace back a century and a half, but unfortunately the share price has failed to reflect its age. Could a smart acquisition inject some much needed vitality into this corporate dinosaur?

For most of its life the company was known as APM – Australian Paper Manufacturers, having established Victoria’s first paper mill on the banks of the Yarra River in Melbourne during the 1860’s. In the 1970s and 1980s the company added a range of diverse packaging interests to its traditional papermaking activities, only changing its name to Amcor Limited in 1986. Over recent decades, the evolution has been caught in a tangle – acquisitions have seen it grow, but the same can’t be said for the wealth of its shareholders. Since the early 90’s, the stock has largely gone sideways.

There have been several attempts to focus operations and unlock shareholder value by selling ‘non core’ assets. The most notable was the de merger of its paper making operations 2001, forming a separate company, Paperlinx (ASX: PPX). The latest restructuring program, ‘The Way Forward’ – was implemented in 2005, when Ken Mackenzie took the reigns as CEO.

‘The Way Forward’ will see Amcor only maintain businesses where it has strong market positions and sustainable competitive advantages. This strategy is sound, as competitive pricing pressures have hampered growth for years, leaving the company open to rising raw material costs. The result has been a chronic battle against falling profit margins. Operating (EBIT) margins have been declining since the early 90s from around 10% to current levels between 5-6%. These unhealthy industry trends have more than offset aggressive cost cutting programs over the years. Apart from a brief period of respite earlier this decade, profits have remained fairly stagnant since the mid 90s’. Unfortunately this flat bottom line performance compares well against measures of shareholder value, with both earnings per share and book value per share in steady decline over the same period. The most recent half year result was consistent with this trend. Operating earnings (EBIT) from continuing operations before significant items fell 2.9% to $316.8m.

As benefits from ‘The Way Forward’ program are expected to flow during FY10, the company should show some respite from these chronic trends over the next 12 months, however the fully geared nature of its balance sheet limits major growth options in the absence of a capital raising. The sale of Rio’s Alcan packaging operation is one such opportunity.

Amcor has confirmed it is in discussions with Rio to acquire part, but not all of the Alcan packaging business, and at the right price a deal does have the potential to create value for Amcor shareholders. Fixed costs are significant in the packaging industry and a merger of these two businesses could yield attractive synergies. Unfortunately, Amcor has a poor track record when it comes to acquisitions.

Buying binges earlier in the decade did not pay off under previous management. Growth in the size of the business came at the expense of shareholder value. Since taking the reigns in 2005, Ken Mackenzie appears to be paying closer attention to shareholder interests. Proceeds raised from $1.25bn worth of asset sales from his restructuring program have been applied to debt reductions, share buybacks ($680m) and reinvested in ‘growth’ areas of the business. Should a deal be struck with Rio at an attractive price, we would consider backing him. However funding hurdles would need to be surpassed, and in the interim we see no need to rush in. Should a capital raising be announced, there’s a good chance of a more attractive entry point emerging.   

In the absence of a deal with Rio, the stock’s investment appeal remains limited. Chronic industry trends continue to override the benefits of restructuring initiatives over the long term. More industry consolidation is needed to reverse the trend. An Amcor-Alcan Packaging tie up could prove just the ticket, but until such evidence emerges, we maintain an avoid rating on the stock for long term investors.

Tim Morris is an analyst at wise-owl.com. Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.

 

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