Ardagh Metal Packaging: Contrarian, High-Risk — And Intriguing
The risks in AMBP are obvious. The rewards might not be.
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In a market like this, the common investing advice is to focus on the long-term and ignore the short-term risks. That advice bodes well for beverage can manufacturer Ardagh Metal Packaging S.A. (AMBP).
As is often the case, however, there’s a catch. In this instance, it’s that there are just so many short-term risks, ranging from macroeconomic pressures to geopolitical concerns. That in turn means that a long position right now both requires some fortitude and raises the prospect of a potentially better entry point in the not too distant future. Given our current belief that the bounce of late is a dangerous bear market rally, we wouldn’t dismiss short-term worries out of hand.
Still, this is a strong company in an attractive sector whose valuation has come down to attractive levels. And one plus (from a short-term perspective) is that AMBP fell last week due to a poor earnings report from a peer, a report that might not read as poorly as the immediate reaction suggests. As with pretty much any stock in this market, investors don’t need to go flying into a long position here. But below $6, Ardagh stock looks intriguing.
Ardagh Metal Packaging S.A.
Based in Luxembourg, Ardagh is a leading manufacturer of metal beverage cans. The company was created in 2016 when Ardagh Group acquired plants from Ball Corporation (BALL) and Rexam, after those companies were required to divest assets to achieve regulatory approval for their merger. Ardagh Group then spun AMP into a special purpose acquisition company, Gores Holdings V, in a merger that closed a year ago.
AMP is a pure-play beverage can supplier, and it serves that end market almost exclusively through aluminum cans: the metal accounted for more than 95% of raw material spend in 2021, per the 20-F. Ardagh operates 24 plants in nine countries, including the U.S. and Brazil. Blue-chip customers include Coca-Cola (KO), Anheuser-Busch InBev (BUD), Guinness manufacturer Diageo (DEO), and Heineken (HEINY).
The market for the most part is controlled by four major players: Ball, Crown Holdings (CCK), privately held Canpack, and AMP. AMP has #2 share in Europe, #3 in North America, and #3 in Brazil (per the SPAC merger presentation). Roughly 43% of 2021 revenue came from the U.S., 45% from Europe, and ~11% from Brazil.
The Broad Case For AMBP Stock
Broadly speaking, there’s an attractive business here. Aluminum can demand has trended upward over time. BALL stock has provided 25-year annualized total returns of over 15% even with disappointing results of late (shares are down 40% from their highs).
Looking forward, demand should continue. Environmental concerns are one key reason why. Aluminum is infinitely recyclable, and despite some flaws, remains clearly preferable to PET (polyethylene terephthalate) plastics. California, for instance, in June passed a law requiring all packaging to be recyclable by 2032, with recycling costs in large part borne by producers. That in turn provides a leg up to metal can manufacturers, including Ardagh, which is building out a plant in Arizona to target that massive market.
AMP itself has had success focusing on specialty packaging, including varying shapes and sizes; specialty cans are tracking toward being more than half of total shipments. The company is also developing “reclosable ends”, an obviously key differentiator for plastic packaging relative to aluminum.
Indeed, the near-term outlook looks solid. On the Q4 call, management said almost 90% of 2024 production already was contracted out. As a result, Ardagh has launched an aggressive plan to expand capacity which should boost shipments. In terms of profit margins, it’s important to note that contracts include pass-through provisions, in which costs are tied to a variety of indices that account for input cost inflation.
Within the sector, the focus on beverage cans also seems like it should provide AMBP stock an edge. About 14% of Ball’s 2021 sales came from aerospace customers; that same year, beverage cans drove just 64% of Crown Holdings revenue. For AMP, the figure is 100%.
So the elevator pitch here is that AMBP is a pure play on a growing (and historically defensive) sector, while trading at a valuation that looks attractive on a relative and absolute basis.
At the moment, that elevator pitch is falling on deaf ears. AMBP stock has been halved from highs reached a few weeks after the SPAC merger closed, and has declined 32% year-to-date.
It’s not terribly difficult to see why. Risks are swirling about the stock. Macroeconomic worries are one obvious concern. After the second quarter earnings report on July 28, Ardagh pulled down its shipment guidance for the year sharply. Adjusted EBITDA guidance after Q4 in February was $775 million; after Q2, it’s down to $710 million. Shipments were guided to be up mid-teens; the expected figure now is in the high-single-digits.
To some extent, macro problems are a factor. Chief executive officer Oliver Graham on the Q2 call highlighted the can industry’s long reliance on promotional activity, which in turns drives volumes and thus can manufacturer shipments. With high inflation, promotional activity has come down, which in turn has reduced volume expectations.
In Europe, the U.K. in particular opened up pubs more quickly than expected, which depressed takeaway revenues at a faster rate than Ardagh projected.
But there are other factors at play. Notably, the hard seltzer category continues to plunge. Ardagh had predicted growth in that industry; after recent updates (notably from customer Boston Beer (SAM)), that prediction clearly was too optimistic. In Europe, amid steep inflation, cost recoveries have lagged.
Ardagh also faces pressure from the stronger dollar, and in particularly the USD/EUR pair. Every penny worth of movement in that pair moves Ardagh’s EBITDA about $2 million. 2022 guidance now contemplates a ~$20 million hit, a roughly 3% headwind against 2021 performance.
Higher interest rates portend a longer-term problem. Ardagh closed Q2 with $3 billion in debt. Though no maturities arrive until 2027, refinancings will be done at a higher rate. The 4% notes due 2029, for instance, yield 6.3%; 3.25% notes due the same year yield 5.1%. Those spreads suggest incremental interest expense probably clearing $40 million, even assuming some debt paydown in the interim.
Considering these factors, the leverage on the balance sheet (~4.5x trailing twelve-month Adjusted EBITDA) and a pair of guidance reductions, it’s perhaps not surprising that AMBP has declined 32% year-to-date. Indeed, the EV/EBITDA multiple assigned to the stock essentially hasn’t moved since the start of 2022. That in turn suggests that AMBP is lower for the most logical reason possible: because the company’s expected earnings are lower.
Has 2022 Performance Been That Bad?
All that said, in context Ardagh’s performance this year actually seems almost impressive. Constant-currency EBITDA guidance suggests a 13% increase year-over-year during a period of significant headwinds. Almost everything — at least so far, for underlying macro demand — has gone wrong. Yet Ardagh’s results are holding up.
To be sure, that growth isn’t necessarily organic in the pure sense of the term. The company spent almost $700 million building out capacity last year, and projects a similar amount of spend this year. Still, Ardagh seems to be outperforming Ball, whose shares plunged after soft Q2 results and commentary last week.
From one perspective, year-to-date results — even accounting for implied guidance for a decline in EBITDA during the second half — highlight the resilience of the business. Because of the pass-through contracts, EBITDA dollars have held up reasonably well. Because end demand is somewhat defensive, shipments have continued to grow (and appear relatively stable even excluding the added capacity). An investor could be forgiven for believing the news should have been far worse.
It’s possible the macroeconomic climate deteriorates further, certainly. But the industry is planning as such: Ball is cutting its capacity plans, and Ardagh is shifting some spend into 2023 and beyond. Even that capacity should be used: North American customers, according to Ardagh commentary, have been importing cans in recent quarters, an uneconomic practice driven by the combination of high demand and supply chain problems.
Ardagh admittedly served some of those customers from its European plants, but between lower capacity and likely reduced imports, there isn’t an obviously onrushing demand cliff. Nor will customers necessarily have a ton of negotiating power in terms of renewing contracts; switching costs aside, it’s not at all clear that there will be the capacity to drive substantial price competition.
Indeed, Graham has said that discussions with customers have gone well so far; quite clearly, customers are well aware of the challenges Ardagh is facing. Indeed, after Q2, the CEO projected “material increases in the profitability of our European businesses” in 2023, as the company manages to recover the unprecedented spikes in energy costs faced this year. (Energy costs are only ~4% of total expense, per past commentary, but the size and speed of energy inflation obviously creates a material headwind.)
Even if the macro picture gets worse, the industry historically holds up well. In each of 2009 and 2010, Ball’s beverage can volumes declined only modestly on an organic basis. The same appears true for Crown Holdings.
Yet none of the long-term trends here appear likely to change much. Sustainability concerns aren’t going anywhere. High aluminum prices potentially could outweigh those concerns, but as long as oil prices remain elevated PET plastics aren’t likely to have a material advantage. Hard seltzer demand probably isn’t coming back, but pre-mixed alcoholic drinks, coffees, and other specialty products should keep growing. And competition will remain intense, but there’s no sign in year-to-date results that Ardagh is falling behind.
If anything, the opposite is true. AMBP stock declined 10% over Thursday and Friday, with the declines apparently driven by BALL’s 23% plunge over the same two sessions.
It’s difficult to see why that is. Ardagh’s results were greeted with a shrug; AMBP barely moved. Ball’s plans for reduced capacity perhaps suggest lower expectations for demand, but those expectations existed to begin with, and that company cited localized problems in the U.S. market for delaying construction of one facility and stopping production at two others.
With that 10% decline, AMBP looks more attractive. Based on 2022 guidance, EV/EBITDA now sits at 10.5x. BALL historically traded at 12x-plus; at the time the Gores-Ardagh merger was announced, its EV/EBITDA was at 15x, while Crown’s beverage can business traded at an implied multiple of 14x. Both multiples admittedly have compressed since (more so in the case of BALL), but AMBP still trades at a discount.
Indeed, AMBP trades at the same multiple to 2022E Adjusted EBITDA as it did in February 2021, when the merger was announced — and when PIPE (private investment in public equity) investors pumped $600 million into the company. Notably, Ardagh was created for 7x EBITDA including synergies in a deal done with sellers whose hand was forced by regulators.
Free cash flow multiples look much more attractive. Maintenance capex came in at $88 million last year; cash taxes are guided this year to $50 million or so, and interest expense (pro forma for the issuance of a perpetual preferred) should be $65 million. Before growth investments, then, the business can throw off close to $500 million in free cash flow.
Some of that free cash flow is going to shareholders. Ardagh’s dividend now yields 6.5%, and the company announced a $200 million share repurchase as well. The latter program was a reversal of the past strategy — Ardagh didn’t want to reduce the float, since Ardagh Group S.A. remains the majority shareholder — and (again per Graham on the Q2 call) was driven by minority shareholder requests for buybacks at this level.
There’s going to be volatility in the stock, and likely in the results. Further weakening in Europe, in particular, could outstrip the company’s ability to pass through costs and lead to sharply lower shipments and lower profits. Add in the leverage on the balance sheet and it’s easy to see how this can get worse in the short- and mid-term. And while Ball has been a long-term winner, CCK has been dead money for a couple of decades; Ardagh is going to need to execute to drive shareholder returns when normalcy returns.
Still, there’s going to be a point when normalcy does return. Execution will be a lot easier at that point, when energy costs aren’t doubling and inflation isn’t at multi-decade highs. And when that point arrives, investor attention will likely return to the very attractive long-term case for the industry, and for Ardagh stock.
As of this writing, Vince Martin has no positions in any securities mentioned.
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This is the second consecutive week we’ve highlighted a packaging industry de-SPAC. Given our attitude toward de-SPACs, we’re as surprised as anyone.
Those figures don’t foot because of rounding and because the figures are prepared on a slightly different basis (point of destination vs. point of production).