Spruce Point Capital Management Releases Report and Strong Sell Research Opinion on Avery Dennison (NYSE: AVY)
Evidence Suggests The Fortune and S&P 500 Company Has Pivoted Toward More Aggressive Accounting Methods And Dependence On Restructuring Charges To Fuel Perceived Margin and Earnings Growth
Expert Interviews Reveal Avery Is Struggling To Innovate With New Sustainable Solutions With Higher Margins And Losing To New Technologies And Consumer Packaging Preferences. Financial Reporting, Including Metrics Impacting Revenue, EBITDA, Free Cash Flow And Its Leverage Are Being Obscured. We Estimate Organic EBIT And Free Cash Flow Have Been In Multiyear Decline
Finds That Director And Former Audit Chairman Peter Barker Obfuscated His Ties To Former Companies Investigated By The SEC. In Two Instances, SEC Inquiries Were Related To Impairment Charges And Required Multiyear Financial Restatements
Spruce Point Estimates That Avery's Shares, Valued Irrationally Above Consensus Broker Targets And Among Material And Chemical Peers, Face Up To 55% Downside Risk. Spruce Point Calls On Avery To Form An Independent Committee And Hire An Independent Investigator To Evaluate Our Findings
NEW YORK, Nov. 10, 2020 /PRNewswire/ -- Spruce Point Capital Management, LLC ("Spruce Point" or "we" or "us"), a New York-based investment management firm that focuses on forensic research and short-selling, today issued an 89-page report entitled "Under Pressure And Sensitive To Declining Results," that outlines why shares of Avery Dennison (NYSE: AVY) ("Avery" or the "Company") face up to 55% downside risk. The full report can be downloaded and viewed at www.sprucepointcap.com. Follow us on Twitter @sprucepointcap for exclusive updates.
Avery is an S&P and Fortune 500 company known for its products and solutions in pressure sensitive labels, adhesives, reflective materials and tapes, and retail branding and information solutions such as RFID tags. Whereas Avery presents itself as a recession resistant and stable Company with growing Adjusted Operating Margins, EBITDA, EPS, and Free Cash Flow, Spruce Point believes its organic financial condition has been inflecting negative for years as its core product loses share to competing technologies and changes in consumer packaging preferences.
Our research shows that Avery has resorted to reducing key financial disclosures and more brazen maneuvers to cover-up its weakening performance including understating debts. Notably, the Company has recorded ~$1 billion of restructuring and impairment charges over the past 20 years. Recent programs implemented during COVID-19 expose the Company, not only to lower earnings leverage when global markets recover, but to financial restatement and investigation risk from the Securities and Exchange Commission ("SEC"). We find evidence that suggests Avery recently modified its restructuring accounting methods, and inaccurately portrayed its historical restructuring accounts to inflate results and unjustly benefit insiders through inflated bonuses.
Spruce Point has limited confidence in the current Audit Committee under Peter K. Barker's leadership, as well. We find an alarming pattern that Avery has failed to disclose his connections to multiple companies and individuals that the SEC has investigated related to recognition of impairment charges. Therefore, Spruce Point calls on Avery to form an independent committee and hire an independent investigator to thoroughly evaluate our findings.
A high-level overview of some of the detailed findings in Spruce Point's 89-page report includes:
- Avery is facing numerous mounting business headwinds, including differentiated competitor offerings. We believe Avery's organic financial condition has been trending negative for years as its core product – the pressure-sensitive label – loses market share to competing technologies and changes in consumer packaging preferences. The two biggest disruptive movements against Avery's business (neither of which the Company adequately publicly discloses) has been the growth of shrink sleeve and flexible packaging, which do not require a pressure sensitive label. Our research shows that shrink sleeves have captured 15-20% of share in the decorative label market. We have identified at least 10 headwinds that the Company has downplayed, ignored, or failed to disclose, including: consolidation through private equity roll-ups among Avery's customers; pressure to move toward more sustainable solutions through R&D expenditures with no discernable payback; the slowing of apparel sales and a shrinking retail footprint as the work from home trend persists; an increase in re-fillable bottle solutions; and customer backward integration of personal laminate machines.
- We believe management is pulling numerous, brazen maneuvers to paper over weak performance to portray margin and cash flow growth to investors. Like many retail dependent businesses, the COVID-19 pandemic has been an absolute body blow to Avery's bottom line. We believe this has pushed the Company to take drastic measures such as:
some text- Accelerated Omission of Key Financial Disclosures. This year, Avery ceased disclosing R&D expenses, operating lease costs (leading to an understatement of debt), and deferred revenues. Over time, Avery has also stopped disclosing price and volume drivers of revenue, revenue from new products, sales return liability, advertising costs and non-cash Capex.
- Dubious Restructuring Charges. We believe Avery has grown so dependent on restructuring charges to perpetuate growth that it has pivoted toward accounting manipulation.
some text- Over the past 20 years, Avery has recorded nearly $1 billion in restructuring charges. As this frequency and magnitude has increased, Free Cash Flow has not structurally increased.
- In a recent 10-K filing, Avery modified its discussion of restructuring accounting methods, and restated its 2018 restructuring charges lower by 62% – without any explanation – leaving its restructuring charge accounts unbalanced by segment. We believe this move allowed the Company to inflate historical Adjusted Operating Income, EBITDA, and EPS.
- We estimate that Avery experienced underlying EBIT contraction between 2015-2019, adjusted for cumulative cost savings from disclosed restructuring programs and acquisitions.
- Obscuring Its Rising Debt Load. Avery is much more expensive and levered than it appears on paper. Our research suggests that the Company not only inflates Adjusted EBITDA and EPS with dubious and annually recurring "one-time" restructuring add-backs, but it also ignores pension and environmental liabilities and obscures operating leases. In total, we believe Avery ignores $364 million of debts in its financial presentation.
- Potentially Misleading and Aggressive Free Cash Flow Presentation. We believe Avery is vastly overstating performance through highly aggressive and analytically flawed methods. Though Avery depicts its Free Cash Flow as growing ~$91 million between 2017-2019, our analysis shows it has actually declined by ~$118 million. Absent extreme 2020 cost cutting measures – targeting $150 million short-term and $65 million of long-term restructuring – cash flow would contract even further. We believe Avery's actions will be a headwind when the global economy recovers, and show how it has been willing to sacrifice long-term earnings potential to meet short-term Wall Street earnings pressures.
- Financial Actions Not Aligned with Forecasts. Avery has waffled on its statement that it can generate $500 million of Free Cash Flow in 2020. Its recent dividend increase of 7% – the lowest growth rate in years – is well below potential. Further, Avery's share repurchases have fallen 75% year over year and are also well below potential given previous forecasts.
- Peter Barker, former Audit Chairman and current Audit Committee member, has obfuscated ties to companies investigated by the SEC. We question why Mr. Barker omits from his biography prior roles at two companies investigated by the SEC. At Stone Energy Corporation (NYSE: SGY) and Fluor Corporation (NYSE: FLR), Mr. Barker served on the Audit Committee when there were full multi-year financial restatements and SEC inquiries into the recognition of charges. At GSC Investment Corp., Mr. Barker served as a director on multiple committees before GSC's external manager GSCP (NJ) L.P. was issued a cease and desist order by the SEC for its selection of certain investments. Further, Avery's proxy statements fail to disclose that Mr. Barker has been a Director at Riverstone Energy Ltd. (LSE: RSE) since 2013. This role connects him with a former Goldman Sachs (NYSE: GS) colleague, David Leuschen, who settled with the New York Attorney General in a state corruption scandal. It also further connects him with an executive whose company is currently under SEC investigation related to impairment charges.
- Avery's Shares Are a Poor Risk / Reward With Up to 55% Downside Risk. Avery's end markets and businesses have yet to recover from COVID-19 and its cost cutting measures have exposed accounting weaknesses and potential loss of competitive position when a rebound occurs. Despite sell-side analysts rewarding Avery with price upgrades to all-time highs, we believe that downside catalysts outweigh upside potential. Avery has consistently missed revenue estimates, while beating "Adjusted" EPS estimates through aggressive cost cuts and lower tax rates. Avery trades at premium to its material and specialty chemical peers on EBITDA and FCF, two metrics which we believe are highly manipulated. In addition, Avery trades 4% above the current sell-side consensus price target of $146.40, which suggests it is overvalued. At 20x our estimate of normalized FCF, and 8.0x-10.0x normalized EBITDA, we estimate a price target of $68 - $99 per share.
Please note that the items summarized in this press release are expanded upon and supported with data, public filings and records, and images in Spruce Point's full report. As a reminder, our full report, along with its investment disclaimers, can be downloaded and viewed at www.sprucepointcap.com.
Spruce Point Capital has a short position in Avery Dennison (NYSE: AVY) and owns derivative securities that stand to benefit if its share price falls.
About Spruce Point
Spruce Point Capital Management, LLC is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities. Spruce Point Capital Management, LLC is a member of the Financial Industry Regulatory Authority, CRD number 288248.
The research note can be found at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
