Why The Amcor + Bemis Merger Is Significantly Underperforming Expectations And The Dividend Is At Risk: 40%-60% Downside Risk

Summary

Amcor and Bemis, two packaging companies, completed a merger in June 2019. Complicated financial reporting between AAS and GAAP, divestitures, and two different fiscal years, obscures underlying results.
Analysts believe Amcor grows 1-2%, but our analysis suggests both companies are organically declining 3-4%. Amcor obscures its ~10% of tobacco cartons sales, a market declining 5%+.
Amcor also makes PET bottles for Pepsi, and plastic bags. Both products are under pressure. Amcor's cost cutting ambitions are aggressive, and we believe behind plan.
We estimate Amcor's FCF fell 51% from 6m 2018 to 6m 2019. Its stock buyback puts the dividend at risk of reduction. Cash liquidity is not clear because of restricted cash and overdrafts.
Amcor has an unresolved material weakness disclosure for 18 months. We find unusual revisions to revenue, capex, and interest income. The Company's Chief Accounting Officer came from Bemis, where he continued to represent himself as a CPA, despite having the qualification revoked by the state of Minnesota
The governance is poor, and insiders just accelerated vesting of long-term compensation. The Head of Audit Committee just left. Insiders own just 0.2% of the stock and have little at risk.
Amcor trades at an in-line valuation with other packaging peers. Yet, we believe it should trade at a discount as its organic sales growth is sharply negative, and margins below peers. Westrock/Kapstone is a perfect comp for what can happen with troubled packaging mergers. At 1.0-1.2x EV/Sales, Amcor would have 40-60% downside risk.

Report Entitled: "A Core Short”

We are pleased to issue a report on our website outlining our concerns how Amcor plc (“AMCR”) faces 40% - 60% downside risk to approximately US$3.60-$5.40 per share. Follow us on Twitter for exclusive updates @sprucepointcap . Below is a synopsis of the report. Please read our disclaimer below.

Amcor plc (NYSE: AMCR | ASX: AMC or “the Company”) is a roll-up, and newly created S&P 500 company, formed through a stock-for-stock merger between Amcor (Australia) and Bemis (U.S.). Its shares trade on both on the NYSE: AMCR and ASX: AMC. As two companies in the global packaging industry with large exposure to the consumer and beverage industry (PET bottles, plastic bags, tobacco), we believe Amcor is facing cost and revenue challenges as the world moves toward healthier and more environmentally conscious solutions. Big customer dependencies include Pepsi and Kraft Heinz. Based on our forensic review of the deal rationale touted by Amcor, we are able to disprove or question a majority of its promotional selling points. We also believe Amcor is obscuring significant financial strain (organic revenue decline 3.0% - 4.0%, cash overdrafts and cash flow contraction) that will place its dividend and BBB investment grade credit rating at risk. We see 40% – 60% downside risk as investors recalibrate the long thesis.

An “Organic” EPS Growth Story Through Suspect Cost Synergies And Obscured Tobacco Dependence:

Nearly 10% of sales are tobacco cartons, yet Amcor’s recent SEC filings and investor presentations disclose “tobacco” zero times! Based on our research, we learned that tobacco cartons once accounted for up to 30% of Amcor’s EBITDA, and may generate margins 1,000bps higher than other businesses. Tobacco sales are declining mid-single digits globally, and Amcor has obscured its goodwill and entities associated with tobacco packaging acquisitions. Amcor even changed its goodwill impairment testing from “quantitative” to “qualitative” factors in 2019. Goodwill accounting is a current hot topic for the SEC, which is investigating Newell Rubbermaid. Other dependencies include plastic bottle sales to Pepsi (~8% sales), and packages to Kraft Heinz (~3.5% sales), which is also under SEC investigation. Amcor claims $180m of Bemis deal cost synergies and avoids discussion of sales synergies. Based on our analysis, deal costs are rising faster than planned, and sales are vanishing. Amcor stopped disclosing Bemis’ sales contribution one full quarter post deal closing. Financial reporting practices for material acquisitions are 12 months of post closing disclosure. Our analysis suggests both Bemis and Amcor sales are organically declining 3.0% - 4.0% and its cost synergy targets, relative to other industry deals, are very aggressive. Amcor’s claim in Feb 2020 that it’s increasing cost synergy guidance from $65m to $80m appears dubious in light of evidence that R&D spending is running $35m below plan. Amcor was adamant at the deal announcement that cost synergies would not include R&D cuts.

Signs of a Cash Crunch Calling Into Question Management’s “Enhanced Financial Profile” Claim:

We believe Amcor presents an inaccurate view of its cash by obscuring clear presentation of rising cash overdrafts and restricted cash. Recently disclosed European filings (30% of sales in Europe) show that Amcor’s cash pool fell into a deficit after a multi-year surplus. Amcor claims rising volumes in Europe, yet didn’t disclose intentions to shut two Flexible facilities in Finland. Rising dependence on cash overdrafts has been a major harbinger of financial strain in companies we’ve warned about (notably XPO and Maxar Technologies), and also played a part in the collapse of the scandal at MDC Partners. Amcor is also intensifying its use of commercial paper (CP), a risky strategy given it was recently downgraded by credit agency Fitch, and as a BBB credit, is close to junk status. As a junk credit, Amcor’s access to the CP market could be restricted, its cost of capital rise, and its liquidity reduced. Amcor embellishes its liquidity by claiming its CP is “long-term” debt, but we believe it should be viewed as short-term.

Why Free Cash Flow Won’t Improve And The Dividend Is At Risk:

In its recent quarter, Amcor became more aggressive with add-backs in its free cash flow presentation, a classic sign of strain. The CFO claims cash flow will seasonally improve through June 2020 (2H’20), but this conflicts with an on the record statement by Bemis’ CEO before the deal closed that its strongest cash generation is in Q3 (June-Sept). Amcor has said that its 3.5% capex to sales spend is “a healthy amount”, but based on our analysis, the average industry capex spend is 5.5%. While all Amcor’s close peers maintain or increase capex spending, we believe Amcor is materially underinvesting in the near-term, a strategy that will depress future free cash flow. Pre-deal Amcor said it required $400m of annual capex to maintain organic growth. However, our analysis shows legacy Amcor capex is running 30%-35% less. We believe Amcor will soon face a crossroads in its financial strategy between completing a $500m share repurchase program, increasing capex to remain competitive, and paying a generous $725m/year dividend. Absent a suspension of repurchases, we believe Amcor will be unlikely to maintain its current dividend.

Leverage Is Greater Than It Appears:

Amcor does not include leases in its presentation of Net Debt to investors. Leases currently amount to $580m, and are now recorded on the Company’s balance sheet. In addition, Amcor has $354m of unfunded employee benefit liabilities. Going against Financial Accounting Standards Board guidance, Amcor does not clearly mark restricted cash amounts in its cash flow statement. However, it disclosed deep in its footnotes that $13.5m was deposited with a Brazilian court to defend a case. In addition, one rating agency views $150m of cash as restricted and necessary for working capital needs. On the surface, the Company tells investors it is levered 2.9x Net Debt / PF Adjusted EBITDA, but with these basic adjustments, we estimate leverage is 3.3x

Unresolved Material Weaknesses And A Chief Accounting Officer That Appears To Have Misrepresented Himself:

Amcor disclosed two material weakness of accounting, disclosure and financial control matters that haven’t been resolved in 18 months. The Company hasn’t been specific about areas affected. Based on our review, we find it has made unusual revisions to revenue, capex, and most alarming, interest income. This bolsters our concerns that cash could be misrepresented. Amcor’s Chief Accounting Officer is Jerry S. Krempa, who came from Bemis where his biography publicly states that he is a CPA. However, based on our background check, his CPA was listed as “REVOKED” by the state of Minnesota for disciplinary reasons in January 2017. In light of our observations, we believe investors should demand a full investigation into Amcor’s financial affairs.

Poor Insider Alignment And Corporate Governance Practices :

In our view, Amcor’s transformation to a global company has left it far behind best practices in global corporate governance. Amcor’s insiders own a measly 0.2% of the stock, and show signs of acting in their own self-interest. To illustrate, Amcor subtly changed the vesting period for long-term stock compensation from 3 to 2 years, consistent with our view that management wants to cash out fast, and is aware the merger is underperforming expectations. Amcor measures its performance relative to a basket of Australian companies (most of which are not even in the paper/packaging industry). This makes no sense given only ~3% of Amcor’s revenues and assets are in Australia. From a governance perspective, we are concerned that Amcor’s lead audit partner at PwC is an industry specialist in Pharma and Life Sciences, and not paper/packaging. In addition, the recent audit chair, another senior PwC global executive, left abruptly amidst heightened scrutiny in Australia about the closeness of the firm to various Australian company Boards.

Few Shareholder Benefits Created By Dual Listing And Slanted Analyst Base: A Poor Risk/Reward Investment Opportunity:

Investors were sold by management that the deal would create “flow-forward” and new index buying demand from a dual U.S./Australian listing. However, based on our analysis we don’t believe this is accurate. We find that Bemis’ top fundamental owners have been selling stock. We believe that Amcor has a large Australian retail investor base that is being baited by local analysts with overly-optimistic price targets. As noted earlier, despite just ~3% of its business based in Australia, 8 out of 12 sell-side analysts covering Amcor reside in Australia. The average price target of A$16.59 / US$10.75 implies 19% upside, and incorporates management’s commentary at face value that it can pull-off a complicated global merger between two disparate cultures, grow revenues 1.5% – 2.0%, while expanding margins and cash flow through multiple different restructuring and cost cutting programs. All of this would be difficult to achieve in a normal environment, setting aside global growth fears from the Coronavirus (Amcor has >$225m of revenue in and around lockdown zones in Italy). Our forensic analysis suggests it may be outright impossible for Amcor to meet lofty analyst expectations, with revenues already vanishing, deal costs higher than planned, and critical maintenance and growth capital expenditures being delayed. Amcor’s valuation is in-line with industry peers, but should trade at a discount to reflect our documented concerns about the accuracy of its financial statements, fragile financial condition and unsustainable dividend policy. Amcor investors should study the recent $5bn Westrock/Kapstonepackaging deal as a comparable example of what to expect. The combined company has repeatedly missed sales forecasts, and is now expected to decline, resulting in significant multiple contraction. Westrock is comparably levered to Amcor, has higher margins, and also has a ~5% dividend yield. If we applied Westrock and its closest peers [Sonoco Products, Berry Plastics, Huhtamakai)] sales multiple of 1.0x – 1.2x to Amcor, it’s easy to justify 40% – 60% downside risk to Amcor’s share price.

Disclaimer

This research note and our presentation expresses our research opinions. You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and calls on the stock) covered herein, including without limitation Amcor plc. (“AMCR”), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and Spruce Point Capital Management does not undertake to update this report or any information contained herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities.

This research note and our presentation expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. You should do your own research and due diligence, with assistance from professional financial, legal and tax experts, before making any investment decision with respect to securities covered herein. All figures assumed to be in US Dollars, unless specified otherwise.

To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of AMCR or other insiders of AMCR that has not been publicly disclosed by AMCR. Therefore, such information contained herein is presented “as is,” without warranty of any kind –whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. You should assume all statements made are our opinions, unless sourced as facts where practical.

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