Positive Outlook For Amcor As Headwinds Ease

This story features AMCOR PLC. For more info SHARE ANALYSIS: AMC

Amcor has reiterated full year guidance, signalling headwinds endured over FY18 are largely temporary while robust cash flow and earnings growth are expected.

-Modest impact from raw material costs expected in the first half
-Catalyst centres on completion of the merger with Bemis
-Should synergy expectations be realised, growth in FY20/21 forecast at 8-9%
 

By Eva Brocklehurst

A solid performance is expected from Amcor ((AMC)) after the company reiterated guidance for FY19 and noted North America, beverage volumes and emerging markets continue to recover.

A reiteration of full year guidance is a signal to Deutsche Bank that the headwinds endured in FY18 have eased and whatever was holding back profit growth was transitory. Strong cash flow and earnings growth are expected, although weighted to the second half because of the timing of costs.

The company has signalled a firm start to the year in the rigid plastics business in Latin America, flexibles in Asia and specialty cartons in Eastern Europe. Citi believes the risk/reward has turned favourable for Amcor and upgrades to Buy from Neutral. While rising bond yields could weigh on the macro outlook the broker is relieved that higher oil prices have not affected the company's raw material pricing to any great extent.

A modest impact from raw material headwinds is expected in the first half of FY19, as cost inputs weigh. Morgan Stanley notes the implied weighting to the second half is consistent with prior commentary and probably reflects the timing of resin recoveries and the phasing in of restructuring and integration costs.

Macquarie acknowledges the traction in recovering higher raw material costs and estimates an earnings impact in the first half of around -US$10m and found it interesting that higher freight costs, which have been issue in the US, are not material for Amcor.

The broker points out that the US business is largely centred on rigid plastics, ahead of the Bemis merger, and freight is mainly accounted for by the customer, supported by Amcor's plants being in close proximity and co-located with customers in a number of cases.

Bemis

The next main catalyst is completion of the merger with Bemis. The company is confident of completing the merger by the first quarter of 2019 and expects shareholders to approve the transaction, despite the reduced takeover premium implied by a lower share price.

Macquarie explains that whilst the premium has diminished, global packaging stocks are down around -11.5% since the bid. The premium in the bid depends on the share price performance of Amcor but also foreign exchange. FX had a $24m positive impact on the company's net profit in FY18, driven by the strengthening of the euro relative to the US dollar.

A resurgent US dollar means FX is likely to be negative for US dollar earnings in FY19. Still, with 95% of sales outside Australasia, a weaker Australian dollar more than offsets this. This is relevant in terms of the share price as well as the Australian dollar valuation, and US dollar dividends when converted into Australian dollars.

Moreover, an all-scrip offer means both sets of shareholders can participate in the value created by the US$180m in cost synergies expected over the next three years.

A completion of the merger is expected to trigger upgrades to consensus forecasts, and Citi estimates earnings growth of 8% in FY20 and 8.7% in FY21. After the merger, Amcor envisages capacity for further acquisitions or share buybacks. Citi calculates, after dividends, cash flow of US$300-400m would enable a 2-3% share buyback.

In Morgan Stanley's base case, a 5% embedded premium is incorporated for the incremental value attributable to the company's capital allocation strategy.

Valuation

Credit Suisse also upgrades, to Outperform from Neutral, as the share price has fallen below its target price. The broker believes Amcor should seamlessly execute the Bemis transaction as the business is well within its expertise and largely based in developed markets. The broker agrees that, should the synergy objectives be delivered, growth in FY20 and FY21 should be 8-9%.

Credit Suisse does stress that, because Amcor has very low cost of capital, the changes to the risk-free assessment can move valuations materially. For example, a 0.5 percentage point increase in US bond yields reduces the discounted cash flow valuation by -US$0.80. Higher bond yields may signal economic growth but the broker points out that Amcor's sources of packaging revenue, such as tobacco, health, food & beverages, are relatively constrained in terms of pricing.

FNArena's database shows six Buy ratings and one Hold (Morgans, yet to update on guidance). The consensus target is $15.23, suggesting 15.3% upside to the last share price. Targets range from $13.34 (Morgans) to $16.65 (Deutsche Bank). The dividend yield on FY19 and FY20 forecasts at current FX values is 4.8% and 5.2% respectively.

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