Avery Dennison Upped to Outperform (AVY) (BMS) (UPMKY)

We have recently upgraded our recommendation on Avery Dennison Corporation (AVY) to Outperform from Underperform; following its strong third quarter results, raised guidance driven by healthy organic growth in both of the core segments – Pressure-Sensitive Materials and Retail Branding and Information Solutions, market share gains and new product introductions. Avery retains a short-term Zacks #1 Rank (Strong Buy), in line with our long term recommendation.

Avery Dennison witnessed 77% annual growth in its adjusted earnings to 53 cents per share in the third quarter, comfortably beating the Zacks Consensus Estimate of 45 cents. Revenues dipped 0.8% year-over-year to $1.49 billion but were ahead of the Zacks Consensus Estimate of $1.487 billion.

In the third quarter, net sales increased approximately 6% on an organic basis, the strongest organic growth since the first quarter of 2011. Higher volumes for pressure sensitive materials and a rebound in the core business of retail branding and information solutions led to the increase. Sales of label and packaging materials grew in every region, with the emerging markets growing in the double-digit range.

Even though the retail branding and information solutions segment had a modest start to the quarter but it finished very strong in the month of September. Sales growth was the strongest among US retailers and brand owners, driven by lower cotton prices and RFID (radio frequency identification) adoption and reflecting rising confidence for next year's spring season.

In order to attain its financial targets of double-digit earnings growth and higher returns, Avery has aggressively implemented a restructuring program in the second quarter of 2012 to reduce costs across all the business segments. The program is anticipated to be completed by mid 2013 and is expected to generate more than $100 million in annualized savings in 2013, including $20 million by the end of 2012.

Avery has decided to divest its long-struggling Office and Consumer Products segment, which has been plagued by weak end market demand. Margins have been affected due to increased investment in demand creation, consumer promotions, and innovation, as well as lower volumes. Avery had earlier agreed to divest the segment to its competitor 3M Company (MMM), but the plan has been terminated by both parties.

Avery is currently looking for prospective buyers and intends to use the proceeds to reduce debt, make additional pension contributions and repurchase shares. With the weaker Office Products business sold out, the company will be able to focus on its market-leading, pressure-sensitive materials business, and Retail Branding and Information Solutions segment.

The company has returned $312 million ($228 million as share repurchases and $84 million as dividends) of cash to shareholders in the first three quarters of 2012. As of September 29, 2012, Avery had approximately $345 million worth of shares remaining under its share buyback authorization. Avery has increased its quarterly dividend by 8% to $0.27 this year, following a 25% hike in 2011. Further share repurchases and dividend hikes could fundamentally improve investor sentiment.

Pasadena, California-based Avery Dennison manufactures pressure-sensitive materials, and a variety of tickets, tags, labels other converted products. Avery has over 200 manufacturing and distribution facilities encompassing more than 60 countries. Its products are sold under the Avery, Avery Dennison, Avery Graphics and Fasson brands. Its clientele is spread across the U.S., Europe, Asia, Latin America and other regions. The company operates through the Pressure-Sensitive Materials unit, the Retail Branding and Information Solutions unit and the Other Specialty Converting Businesses unit. Avery Dennison also competes with Bemis Company, Inc. (BMS) and UPM-Kymmene Oyj (UPMKY).