Amcor unpacks a demerger success

Demerging its packaging distribution arm will give a clearer growth picture for Amcor's higher-performing global flexibles businesses.

Amcor’s Ken Mackenzie didn’t try to gild any lilies when he described the Australasia and packaging distribution businesses he plans to demerge later this year, which helps understand why he plans to demerge them.

In announcing the Amcor result for the year to June (and a solid result it was) Mackenzie described the businesses he proposes to spin off, which Amcor refers to as its AAPD businesses, as “defensive” and “resilient”, with earnings that would essentially track the GDP of Australasia and North America.

The earnings before interest and tax of the AAPD businesses actually slipped 4.1 per cent for the year, to $146.2 million, on sales that edged up 2.5 per cent. The group’s earnings before interest and tax were up 6.8 per cent and its after-tax earnings 8.6 per cent to $689.5 million, with its flexibles business increasing EBIT by 11.9 per cent and its rigid plastics business 5.2 per cent in local currency terms.

The flexibles and rigid plastics businesses will form the continuing Amcor. They are businesses with strong margins and which produced attractive returns on funds employed – the flexibles division generated a 24 per cent EBIT return on average funds employed ratio and the rigid plastics division a 16.9 per cent return.

Both those divisions have global footprints and have growth prospects in emerging markets and via acquisitions.

By contrast, AAPD has had modest top line growth and generated a return on average funds employed of a far more modest 8.9 per cent in the year to June. It is a dampener on the performance statistics of the larger group.

While Mackenzie didn’t exactly pump up the tyres on the businesses he plans to demerge, neither did he talk down their near-term prospects for significantly improving their profitability. Amcor has invested about $1 billion in recent years in restructuring the businesses, including a $500 million or so investment in a new recycled paper mill at Botany in New South Wales.

The restructuring of the Australasian business is expected to generate $93 million of cost reductions over time, $12 million of which flowed through to the most recent results. This financial year it expects to extract a further $30 million to $40 million.

So while the top line might move only modestly in line with GDP growth over the next few years, the bottom line ought to be supported and lifted by the structural reduction in costs. In the context of EBIT of around $150 million a year the scale of the cost-reduction program is extremely material

Mackenzie is also hopeful that, freed from the parent group, the management of AAPD will be able to generate some product innovation to tweak the top line.

AAPD will, all going well, be spun off before the end of the year, with Amcor disclosing today it expects the new listing to carry between $700 million to $750 million of debt. AAPD has total funds employed of about $1.65 billion, so it won’t be excessively geared and it contains a set of businesses that generate very strong cash flows and which could therefore support either a new growth strategy or strong cash returns to shareholders.

Freed of the lower-returning AAPD business and the debt that will be shifted to them, the continuing Amcor will be a clearer proposition.

One of the most attractive aspects of Amcor is that it operates, and has global market leadership, in very defensive industry segments and therefore there is an inherent stability to its financials that has been stress-tested by the post-financial crisis environment. It has, however, also been able to generate strong growth through its cost discipline and its expansion, both organic and by acquisition, into emerging markets.

Since 2010 it has generated compound annual sales growth of 16 per cent and EBIT growth of 19 per cent in emerging markets, with almost 60 per cent of the sales growth organic. It now has $2.6 billion of sales in those markets – 29 per cent of its sales base in the flexibles and rigid plastics divisions.

Freed of the more mature AAPD businesses that story of high-quality growth should be more evident and easier to tell.