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Avery Dennison Corp. (NYSE:AVY) is coming off a decent quarter considering FX, supply chain and inventory headwinds it faces. These are getting more challenging in the fourth quarter because of the need for retailers to move inventory in order to stock up on new items.
For that reason, the fourth quarter is probably going to be a tough one for AVY, and possibly the first couple of quarters of 2023, depending on how consumers response to the weak economic conditions. The other factor is whether or not the recession is going to go deeper for longer, which would force customers to make decisions concerning what they’re going to spend money on.
Under that scenario retails sales would pull back and demand for AVY’s pressure-sensitive materials and products would decline.
In this article we’ll look at some of the numbers from its last earnings report, and what the future looks like for the company over the next year or so.
Latest earnings
Revenue in the third quarter was $2.32 billion, beating by $13.14 million. Last year in the same quarter the company generated $2.071 billion in revenue. EPS was $2.46, missing by $0.03. but up 15 percent year-over-year.
Third quarter gross profit was $619.2 million, an improvement over the $554.4 million in gross profits in the third quarter of 2021.
Adjusted EBITDA climbed 13 percent in the quarter, with an adjusted EBITDA margin of 15.6 percent, up 20 basis points from the third quarter of 2021. Some of that was from the company raising prices in response to inflation.
AVY continues to generate a lot of cash flow, with $140 million in free cash flow in the third quarter, and $425 million year-to-date. That was lower than last year in the same reporting period, primarily from FX, an increase in capital spending, and higher working capital. In relationship to working capital, the company considers that to be, for the most part, temporary.
With the company expected to slow down in the current quarter, and possibly in the next couple of quarters, free cash flow is likely to decline some.
At the end of the reporting period AVY had cash and cash equivalents of $128.2 million, down from the $162.7 million it had to start 2022 with. Long-term debt and finance leases were $2,462.9 billion in Q3. The company had a net debt to adjusted EBITDA ratio 2.1 as of the end of Q3.
Even with a probable decline in free cash flow, I think the company will still have more than enough to invest in acquisitions and growth initiatives.
And while the amount of cash it returns to shareholders may also decline from the $497 million it returned in the first nine months of 2022; it should be able to still return a significant amount going forward. Again, the only thing I see changing that outcome would be if the recession turned severe and is prolonged. The strength of the U.S. dollar will also play a role because of AVY’s international exposure. We’ll also need to see the impact of excess inventory on retailers in the current quarter to get a clearer picture on the short-term prospects for AVY.
How segments performed
Label and Graphic Materials
Sales in Label and Graphic Materials jumped 20 percent organically in the quarter, with almost all of that coming from raising prices.
The company experienced growth in both its base business and high-value product categories. Western Europe was the leader in this segment, with revenue up by about 40 percent. Volume growth and stronger pricing from that region having the highest level of inflation, were the key catalysts. Other growth markets were India with 40 percent growth, and Latin America with 25 percent growth. North American sales on the other hand were up a more modest mid-teens because of lower volume as supply chain constraints continue to impact that market. Pricing offset some of that.
Company-related inflation is expected to be 20 percent for the year, driven by increasing paper and energy costs.
Retail Branding and Information Solutions
Sales in Retail Branding and Information Solutions were 7 percent in Q3, and 22 percent when excluding FX.
Adjusted EBITDA was up 19 percent, and adjusted EBITDA margin of 18.9 percent. That was led by higher volume and acquisitions. While its base business was down in the segment, Intelligent Labels and external embellishments continue to perform well.
Revenue in Intelligent Labels was up 20 percent in the quarter, and the company believes it’ll continue to grow above that pace on an annual basis in the years ahead.
Industrial and Healthcare Materials
Sales in Industrial and Healthcare Materials were up 5 percent, primarily driven by higher prices.
Healthcare sales led the segment with revenue climbing into the mid-teens, while industrial revenue was up in the high single digits. A drop in retail in the mid-teens offset some of its performance.
Not including FX, Adjusted EBITDA was up eight 8 percent, and a modest four percent when including the effect of FX on the numbers. Adjusted EBITDA margin of was 14.3 percent, a gain of 90 basis points over last year in the same quarter, and up 60 basis points from the prior quarter.
Looking ahead
The company lowered it guidance for adjusted earnings per share to be in the range of $9.70 and $9.85, although that should still be about 10 percent earnings growth above the third quarter of 2021. Without the FX effect EPS growth would be approximately 18 percent growth.
Overall revenue growth for the full-year 2022 is expected to be about 16 percent, slightly below previous guidance. The reason for that is the company expects lower volume in closing out the year.
For all of 2022 the company sees the impact of FX to be around $77 million, based on current rates. Assuming rates remain close to where they are at this time, currency headwinds in 2023 is expected to have an impact of $0.50.
Operating expenses are guided to be approximately $35 million, while CapEx should be about $350 million.
Conclusion
While I agree with management that under the economic circumstances if faced in the quarter that it performed well, I think, for now, the best is now behind it.
I don’t mean by that, that its performance and share price are necessarily going to crash, but with high interest rates and a strong U.S. dollar, along with supply chain and inventory issues that, in some cases, aren’t clear as to the impact it’ll have on the industry in general, and AVY in particular, I see the company having its momentum slowed down and probably facing two or three challenging quarters.
And if the recession goes deeper and wider, its customers will likely tighten up expenditures, lowering demand in some of its segments.
After a nice run in its share price starting in February 2021, the company, after a period of consolidation ending in early January 2022, has since pulled back highs of around $227 per share, all the way down to its 52-week low of $151.62 per share on June 13, 2022. It has since rebounded some but has struggled to break out since then. It had a brief jump to a little over $200 per share in mid-August 2022, but has since pulled back, trading at about $183 per share as I write. The share price of AVY is likely to remain choppy for some time, with the probable outcome being lower lows and lower highs.
Longer term I believe AVY is going to do okay, but over the next several quarters it’s probably going to struggle to gain traction. In the near term, when it pulls back, it’s going to provide some decent entry points for investors’ interest in the company.
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