BUY HOLD SELL

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Tuesday, 12 February 2019
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BUY HOLD SELL - AMC

AMC has been in the news of late given their takeover of Bemis Company, in a US$6.8bn, all-scrip buyout of the US packaging company. The takeover will make Amcor the world’s largest plastic packaging group and leader in flexible packaging, with a market cap of US$17bn and revenues of US$13bn.

Overnight, AMC and Bemis issued a press release following the European Commission’s approval of their merger. A condition of the approval is an agreement to divest three Bemis plants located in the United Kingdom and Ireland. Combined these plants generate approximately $170m of annual revenue from the sale of flexible packaging for certain healthcare products. This is immaterial given the projected revenues of the combined entity noted above (US$13bn). The merger is yet to receive approval from the US Federal Trade Commission (FTC) and isn’t expected to do so now until the second quarter of 2019, due to the recent government shutdown.

Bemis operates 56 packaging plants in 12 countries, primarily in the US. Amcor operates 195 packaging plants in 43 countries. Amcor's corporate headquarters are in Zurich in Switzerland after it decided to shift most of the head office roles from its traditional Melbourne home in 2015.

The deal for Amcor appears to be primarily about expansion rather than consolidation. Whilst AMC has a solid international presence, the company’s market share in the Americas is comparatively small compared to other countries. Acquiring Bemis changes this significantly – Bemis has a leading presence in the Americas, particularly North America, which accounted for 70% of the company’s 2017 sales. According to estimates, Amcor post the merger will have flexible packaging sales in the Americas of just over US$4bn, a sharp increase over current sales of approximately US$1bn.

Taking over Bemis will also grant Amcor immediate entry into the South American market, notably Mexico and Brazil. This is likely to be complementary to Amcor's existing portfolio of operations in Central and South America, including market-leading positions in Peru, Colombia, Chile, and Argentina.

Amcor chief executive Ron Delia said the anticipated cost savings of $US180m by the end of the third year from bringing the two businesses together was conservative. Savings will emanate from synergies in procurement, manufacturing and administration. However, the $180m figure focuses only on costs and does not take into account cross-selling opportunities. 

Other opportunities could come in the form of further acquisitions. Both Amcor and Bemis have active histories of growth through transaction. The merger could also unleash a new wave of innovation. Both companies have considerable research and development departments which, when combined, should lead to greater efficiencies in the manufacturing process, as well as new products. 

THE NUMBERS - These are the numbers from our STOCK BOX.

Main observations:

  • ROE is a remarkable 66.7% and is expected to remain high in future periods. Whilst a high ROE is good, in this case the ROE is being driven by debt (which has been taken on for the Bemis takeover). AMC’s debt-to-equity ratio is 2.5x, which is very high.
  • Revenue growth is modest at 1% this year and expected to average 3% in the next three years.
  • EPS growth is more impressive at 3% this year and expected to be 8%, 7% and 11% in the next three years. This is a good sign as management is expected to drive efficiencies from the takeover.
  • The stock is not overly expensive, trading on 21.6x this year, dropping to 16.9x three years out.
  • 10 brokers cover the stock, with 8 rating it as a BUY or better.
  • AMC is trading at a 19.8% discount to intrinsic value
  • It is also trading at an 8.6% discount to the average Thomson Reuters analyst's target price.
  • Yield is reasonable, at 3.5% this year and expected to grow to 4.2% in the next three years.

WHAT SORT OF INVESTMENT IS AMC?

If you buy AMC now, you are buying two major types of risk. Merger risk and global economy risk. You are buying AMC in anticipation that the two companies can me merged efficiently and effectively, and drive synergies. A merger of this size is not without its risks but both companies has a successful history of acquisitions. As for global economy risk, packaging is directly tied to consumption – people buying more goods from Amazon means more boxes. If the global economy slows, packaging sales would be expected to also slow.

BROKER RECOMMENDATIONS

Most brokers like the stock and have price targets circa 5%-10% above the current market price. Citi was out yesterday noting that 1H results were in line with their expectations and that headwinds from raw material costs are expected to reverse in the second half.

SHORT TERM TECHNICAL VIEW

AMC has endured a volatile six months. From a high around 1530c in early August, the stock plunged to a low of 1267c toward the end of October – a decline of 17%. Since touching that low, the stock has roared back to currently be trading around 1450c. Immediate momentum is now decidedly bullish.

CONCLUSION

In the past, Amcor had also been viewed as a "bond proxy" because of its defensive attributes, stable free cash flow and dividends with low volatility. Over the longer-term, Amcor's share price has a fairly strong correlation with the US 10-year bond yield. That is likely to still be the case but the acquisition changes the investment case significantly. The scale alone means AMC will be more efficient and seemingly able to acquire more market share – particularly in regions where it has previously struggled for penetration. Whilst there is execution risk, that is risk we are willing to take on given both companies’ history of acquisitions. We would be happy to accumulate around current prices.

One thing to bear in mind, is that once the merger is completed, AMC will move its primary listing to the US as it goes global. AMC will still trade on the ASX as a Chess Depository Interest (CDI). Given this, the main driver for share price moves will be US investors rather than local investors. JHG and JHX are examples of a CDI. They have all the same economic benefits as ordinary shares including dividends. It should not make any difference but worth pointing out.

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