FO Fortune Brands

We have recently downgraded our recommendation on Avery Dennison Corporation (AVY) from Neutral to Underperform reflecting lower volume expectations for the remainder of 2011, a higher tax rate and weak results in two of its largest businesses. The shares of Avery Dennison are currently maintaining a Zacks #5 Rank (Strong Sell rating) over the short term that corresponds with our Underperform recommendation.

Avery Dennison reported a disappointing third quarter with its adjusted EPS of 48 cents falling short of both the Zacks Consensus Estimate of 59 cents and 62 cents in the year-ago quarter. However, revenues of $1.7 billion rose 4% year over year and outperformed the Zacks Consensus Estimate. Revenue increased in two segments – Pressure-sensitive Materials and Other specialty converting businesses while the remaining two - Retail Branding and Information Solutions as well as Office and Consumer Products registered declines.

For fiscal 2011, management provided adjusted EPS guidance in the range of $2.15 to $2.30.  The Zacks Consensus Estimate for Avery currently stands at $2.23, the midpoint of the guided range.

Avery experienced unexpected declines in volumes across all geographical regions in the second quarter which continued into the third. Specifically, its two largest businesses; Pressure-Sensitive Materials and Retail Branding and Information Solutions were affected. In the Retail Branding segment, a major factor in the decline was the dramatic run-up in material and labor cost for apparel, which made retailers cautious about ordering garments with correspondingly higher prices, especially in an environment of uncertain consumer demand.

Pressure-Sensitive Materials volumes were affected as like apparel retailers and brands, consumer packaged goods companies are also cautious about consumer spending and are managing inventories tightly. This trend is expected to continue in the fourth quarter as well.

The Office and Consumer Products segment’s volumes and sales have shown continued weakness due to weak end market demand and increased competition in the label category. Margins have been affected by increased investment in demand creation, consumer promotions, and innovation, as well as lower volume.

Avery forecasts its tax rate for 2011 in the low 30% range versus a range of 9–23% over the 2005–2010 timeframe. The primary reason for the increased tax rate is reduced expectation for pretax income outside the U.S.

Avery reduced its previous free cash flow guidance for 2011 of $250 million to $275 million to a range of $215–230 million, the lowest annual free cash flow since 2003. This reflects a muted profit outlook, reduced capital spending of $145 million (previously $150 million) and higher pension contribution pension plan of $70 million in 2011.

On the positive side, while volumes were lower across most segments, the company was successful in offsetting raw material costs by implementing price increases over the past several quarters across its various products and regions. Avery's raw material inflation guidance of $220 million for fiscal 2011 remained unchanged. This should be largely offset by additional cost reduction initiatives and pricing actions.

The company has aggressively cut costs, to the tune of nearly $160 million in expected annual savings. Annualized savings associated with 2011 restructuring actions are now expected to total approximately $55 million, with about one fourth of the benefit to be realized this year. Avery continues to evaluate further opportunities to reduce costs, potentially including additional restructuring actions.

Avery remains focused on launching new products and has a target of $20 million to $30 million for new product sales during 2011. Customer commitments for these new products are on track with the target. A combination of these new products plus the normal seasonal impact of back-to-school will drive improved sales trends and enable the company to achieve its full-year margin targets.

Avery has increased its quarterly dividend by 25% to 25 cents this year. The company had earlier halved its quarterly dividend from 41 cents to 20 cents in 2009 due to continued poor market conditions, along with increased pension funding requirements and debt reduction efforts. Avery had last increased its dividend in 2007, marking the end of its 32-year streak of consistent dividend increases. We expect the company to resume its trend of dividend hikes.

Pasadena, California-based Avery Dennison produces pressure-sensitive materials, office products and a variety of tickets, tags, labels and other converted products. Avery is a Fortune 500 company operating over 200 manufacturing and distribution facilities with roughly 32,000 employees in more than 60 countries. It primarily competes with Bemis Company Inc. (BMS) and Fortune Brands Inc. (FO).

 
AVERY DENNISON (AVY): Free Stock Analysis Report
 
BEMIS (BMS): Free Stock Analysis Report
 
To read this article on Zacks.com click here.
 
Zacks Investment Research