Avery Dennison

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Avery Dennison is a global materials science and digital identification solutions company that provides a wide range of branding and information solutions that enable greater efficiency and visibility across the supply chain.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Avery Dennison (AVY) is a global manufacturer and distributor of pressure-sensitive materials (such as labels), tags, and other related materials used for packaging, branding, and identification purposes. The company operates through two main segments:

  • Materials Group: Produces and sells pressure-sensitive materials used in labels, graphics, tapes, and other applications. This segment focuses on providing materials for product branding, identification, and functional needs across a variety of industries. This is their main revenue driver.
  • Solutions Group: Develops and sells solutions that include radio-frequency identification (RFID) technology, software, and digital printing. These solutions are designed to enhance supply chain management, product authentication, and customer engagement through more accurate data collection and tracking systems.

Revenues Distribution: A geographical breakdown of its business shows that roughly 40% of sales comes from the United States with other regions of the world having a roughly equal distribution. These other regions include Europe, the Middle East, and North America, Asia Pacific, and Latin America. * In the Materials group segment of the business, most products are sold to distributors or applicators who then sell the labels to end-users, while some large customers buy directly from Avery. The Solutions segment sells products and services directly to customers in a variety of industries. * The company’s sales are not concentrated on any particular client but are diversified between a very wide variety of them. Most customers are large-scale, long-term and recurring customers.

Trends in the Industry: The company operates in mature markets for its traditional businesses, including labels and other material production, but these markets are undergoing changes driven by trends in technology. There is a transition towards digital identification and tracking systems (RFID) that provides the customer with more accurate data. These changes are requiring that AVY also evolve to better provide the customer with these more sophisticated tools.

  • The shift towards sustainable materials and responsible production practices. This is a high priority for both governments and consumers.
  • The shift towards e-commerce and direct-to-consumer channels will impact how supply chains are managed and the type of identification and tracking they need.

Margins: The operating margin for the company was 11% for 2023, which was an increase over the previous years. * The gross margin is 27.6% for 2023 which is up from 26.7% in 2022.

  • The Solutions business segment reported an operating margin of 8% in 2022 and 11.6% in 2023.

Competitive Landscape: While Avery Dennison operates in a somewhat niche field, it does not operate without competition. The Materials group faces competition from other large scale producers and regional and local players. The Solutions group faces competition from other technology providers with a similar focus.

What Makes Avery Dennison Different: Avery Dennison’s advantage comes from scale, long relationships with customers, high switching costs, and its capacity to create innovative products.

  • It has a broad range of products and solutions and they have manufacturing capabilities all over the world, which ensures reliable and prompt deliveries and lowers their own costs.
  • It has invested heavily in R&D, providing more advanced solutions such as RFID systems to its customers.
  • The integration of their products into their clients operations creates high switching costs, which create recurring revenue streams.
  • The company’s relationships with well-known and large clients and brands is another source of a strong competitive position.

Financials

  • Revenues: AVY has shown steady revenue growth over the past few years, going from $8.4 billion in 2021 to $9.0 billion in 2022 to $9.1 billion in 2023.
  • Profitability: The company’s profits, while still significant, have not expanded at the same rate as revenue, leading to a slightly decreased net margin of 7.2% in 2023, compared to 9% in 2022 and 8.5% in 2021. This suggests possible challenges in controlling expenses or a slight increase in competition.
  • Debt: The company’s total debt is currently $3.4 billion, which is a little higher than in previous years, however, they have sufficient free cash flow to maintain this debt. They also seem to have good access to the market and can refinance debt at low interest rates.
  • Cashflow: Free cashflow is around $589 million, which is more than enough to pay for current dividend payments and maintain their current capex and R&D projects.
  • Valuation: The P/E ratio is around 25-26 and market cap is around $17.5 billion

Moat: 3 / 5

  • AVY has a narrow moat, stemming from its scale, customer relationships, high switching costs, and ability to innovate, particularly in their solutions segment.
  • However, the commoditized nature of some of their products and the competitiveness of the markets they are exposed to limits their pricing power and ability to maintain above average returns on capital in all their business lines, thus limiting the strength of their moat.

Understandability: 2 / 5

  • Although they provide products which are simple in theory like labels or tags, the specifics of production and the supply chain is quite complex and not easy to understand. It is also not easy to gauge the competitiveness and relative performance of their Solutions segment.
  • For a retail investor or a typical analyst, the business might not be super easy to fully comprehend.

Balance Sheet Health: 4 / 5

  • The balance sheet is in pretty good shape with reasonable amounts of debt in comparison to revenue.
  • They have enough free cash flow to maintain current operations and still invest in future development
  • They have enough liquidity to maintain a consistent level of operations.

Risks to the Moat and Business Resilience

  1. Commoditization: If customers begin focusing purely on price, it might undermine its high margins.
  2. Technological Disruption: New technologies from competitors or the obsolesce of some current tech could pose a threat to the company. This is a constant risk in tech-related businesses.
  3. Economic Sensitivity: AVY is vulnerable to economic downturns that would reduce the production of goods and therefore the need for their labels.
  4. Raw material prices: Changes in input costs like paper or specialty chemicals can affect the margins of the company.
  5. Concentration of Customers: Although not a big issue right now, having their clients in a few different industries means some major changes in those sectors could have a great impact on AVY.
  6. Inflation: Inflation can potentially cause an increase in operating costs and a decrease in profitability if not passed on to the consumer.
  7. Foreign Exchange Risk: As they operate worldwide, the company is exposed to changes in the valuation of currencies which could hurt their financials.

Latest Concerns, Controversies and Management Response:

  • In the most recent earnings call and report, investors expressed some unease in the amount of restructuring costs that have been going on. For 2023, these amounted to $174 million. Management explained that this is part of a multi-year plan for consolidation and efficiencies. They anticipate that this will lead to a decrease in operating costs and more favorable financial position in the coming years.
  • There is a slowdown in some of their markets in 2023, which is negatively affecting margins. This can be explained by the lower sales in the consumer discretionary sector and reduced growth due to the current economic condition.
  • Management is confident that a reduction in capex and working capital will make way for future growth in FCF.

Conclusion

Avery Dennison is a company that has a consistent source of demand for its products and services with good financials, but there are some challenges for the company in maintaining strong competitive advantages that are mostly based on scale and client relationships. It seems to be worth investing in given the right price and a long-term outlook.