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Treasure Chest: Material Upside For Amcor

Treasure Chest | Apr 17 2018

Bank of America Merrill Lynch has set a Buy rating for Amcor, suggesting the market has factored in what are likely only short term issues.

-Limited scope for further acquisitions
-Cost inflation issues easing
-Share price offering upside risk

By Greg Peel

Since peaking in June last year, the share price of multinational packaging company Amcor ((AMC)) has fallen -14%. The ASX200 has risen 2.6% in that period, and was up 7% in January before US inflation risk, trade war fears and various geopolitical developments reintroduced market volatility.

The reasons for Amcor’s recent weakness are largely twofold – rising raw material costs and an underwhelming performance from its two most recent acquisitions. Amcor’s acquisition program post-GFC proved company-defining. The ASX200 is up 63% from the March 2009 trough while in the same period Amcor’s share price has tripled.

The question for investors is as to whether the company can no longer rely on acquisitions for growth, and as to whether higher raw material costs are a cyclical or structural headwind.

Earlier this month, Citi analysts noted a Canadian packaging company acquired the flexibles business of a US company for an estimated 7% return on funds engaged. Amcor’s “hurdle rate” when considering acquisitions is 20% after three years.

Citi notes Amcor’s last “key” acquisition was in 2016. This most recent example of industry consolidation suggests patience will be required, and an easing of valuations, before Amcor could make another key acquisition.

Bank of America Merrill Lynch suggests relying on acquisitions to support total shareholder return (TSR) is currently a risk, given high asset values for fragmented businesses. BAML further noted the company’s net debt to earnings ratio is around 3x, which the broker sees as a little high and possibly restrictive to future acquisitions.

Yet BAML has reinstated coverage of Amcor with a Buy rating.

A Matter of Price

A bullish view towards the stock, the analysts suggest, is that current negative influences – raw material costs and underwhelming performance from recent acquisitions – are short term and cyclical, meaning they should mean-revert, leading earnings to bounce back. A bearish view sees the influences being more structural, or current weakness being caused by flaws in Amcor’s execution.

BAML’s view is more bullish than bearish. Indeed the analysts suggest there is “materially” more upside risk than downside risk.

Amcor has still managed to grow earnings through a tough period, the analysts note. They are confident the company’s overall execution in Emerging Markets is sound, although two factors need to be addressed — being able to pass on raw material cost increases and improving the performance of recent acquisitions.

The key driver of the broker’s Buy rating is nevertheless a matter of share price. In the bull case, BAML values the stock at $19.40, and in the bear case at $13.73. The current share price ($14.18 at time of writing) suggests the worst case scenario is already factored in.

The broker’s base case valuation results in a 12-month price target of $17.00, implying an “undemanding” 18.9x FY19 forecast earnings multiple and a TSR of 27%.

Morgan Stanley, too, believes value is undemanding. Last week the broker noted Amcor was trading at an -18% discount to the industrials ex-financials index, despite having an earnings growth profile consistent with the sector.

Morgan Stanley acknowledges the pressures Amcor has faced in the last 12-18 months but sees those as cyclical, and suggests there are early signs of easing. The broker believes the company is now better placed to deal with cost inflation, and has lifted its rating to Equal-Weight from Underweight while setting a $14.80 target.

The FNArena broker database, which does not include BAML, shows four Hold or equivalent ratings and three Buy. The consensus target price is $15.56, on a range from $14.20 (Credit Suisse) to $18.20 (Deutsche Bank).

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