Ardagh Metal Packaging S.A. (AMBP) Earnings Call Transcript & Summary

All right. Well, good morning, everyone. My name is Curt Woodworth, paper and packaging analyst here at Credit Suisse. Very pleased to have Ardagh Metal Packaging with us today. Oliver Graham, CEO; David Bourne, CFO. Maybe Oliver, you can provide some opening introductory remarks, and then we can go into Q&A format.

Sure. Yes, delighted. So thank you for having us here, Curt. So we came out with our Q3 relatively recently. And like the rest of the industry, Q3 was a challenging quarter for ourselves, beverage cans. Although we grew 9%, and that was below our expectations, and so our profits came in below where we'd signaled them. And as a result of that, I think we like the rest of the industry are now getting very focused on costs, capacity management, being very disciplined with the way we operate over the next few quarters. And we'll be bringing down our growth CapEx, our business growth investment projections for next year, they'll come in significantly below where we see them this year. If we look at the year-to-date and again commented on by most of the big beverage can manufacturers now, a number of things differed from expectations. So the hard seltzer market, I think did not perform, down nearly mid-teens. Then we saw the big inflation come through in pricing at retail, and that affected volumes on the can side. And, of course, in Europe, we had a war in Mainland Europe, that led to a big kick in inflation and impact on freight costs on supply chains. So we had a lot of disruption on the European side. In Brazil, we did have big inflation as well, which impacted volumes, but we did well in Brazil, we gained a bit of share. So we actually had a good year in Brazil. Overall, and we can talk about this more. We still see the strong secular trends supporting the beverage can. We still see those as intact. If you go back to 2019, you go pre-pandemic, pre-inflation, pre-everything, beverage cans grew at 6% in Europe, they grew at 3.5% in North America, and they grew 15% in Brazil. And we think the drivers of those trends, the sustainability drivers, the anti-plastic agenda, the innovation that's going into the cans, those are all still intact, and that's why we're confidently predicting low single-digit growth in North America and Europe next year and mid-single digits in Brazil. We've been on a significant growth program. Since the SPAC and sort of during and post SPAC listing, that will be 80% to 90% complete by the end of next year. So we're sitting with good capacity to grow into as the growth comes back. We're also pushing heavily on our sustainability agenda. So we were pleased to get approved by the Science-Based Target Institute. In Q3, we were awarded a platinum rating on EcoVadis, obviously very important to us. And we've been investing significantly in education in the communities that we operate in. So we invest in schools and science-based education. For the remainder of 2022, we pulled down our guidance. So we pulled to a mid-single-digit volume number. We pulled to a $640 million to $650 million EBITDA range from the $710 million we've been out in Q2. We haven't guided on 2023, but we do see profit and volume growth into 2023 of 2022. And that's on the back of some good inflation recovery. We see that we've put in place some pretty robust mechanisms particularly to deal with European energy inflation. So we're very confident about our inflation recovery going into 2023. So with that, I'll just hand over to David for a couple of remarks, and then we can take questions.

Perfect. Thanks, Ollie. Look, as indicated, we're not going to provide detailed 2023 guidance ahead of our update to the market in February. But aligned to the comments of our growth investment plans well advanced and with a further flexing of those plans, we expect growth investment in 2023 to fall significantly from 2022 levels. With an increased focus on near-term cash generation, we do not expect to seek to go to market to raise any financing through FY '23. AMP continues to operate with a very strong balance sheet with approximately $1 billion of liquidity at both Q3 and in our projections for the year-end. And we've also got a well termed out capital structure with none of the green bonds, which are on attractive fixed rate terms maturing before 2027. In this context and with an increased focus on near-term cash generation, we view our $0.10 quarterly dividend as sustainable. Our cash flow generation will clearly improve further as we grow into our expanded capacity footprint over the coming years. So with that, Curt, I'll hand back to you for questions.

Great. Appreciate it. Maybe we could just unpack the quarter and kind of the operating model, if you will, of the business. Because I recall a couple of quarters prior, the business actually had negative or limited growth, but actually grew EBITDA fairly sizably. And in this case, last quarter, you have 9% growth, but more headwinds relative to EBITDA generation. So there's somewhat counterintuitive things. I know in the past, there's mix optimization and the ability to maybe downside from a more profitable spot customers that maybe weren't existent. But as we think about operating leverage in the model going forward, how do you think about kind of fixing some of these under-absorption issues? I know you discussed you had some inventory-related issues on having too much metal and then you didn't get the sell-through on top of that. But maybe you could just help us understand a little bit more the operating model going into next year would be helpful?

Yes. I think, I mean, certainly, the back end of last year and early this year, we had some strong mix benefits from the customers we were taking on that offset some of the growth reduction. And that was mainly in Americas. So particularly in North and South America, we had some favorable mix impacts that didn't persist in Q3 of this year. And then the big thing going on in Q3 of this year that affected profit was the decline in the seltzer piece, which was, therefore, a negative mix piece. And then the European inflation picture with energy costs and other costs coming through very strongly into our P&L. So that's why the volume growth in Q3 didn't translate as well into profit recovery as we were seeing at the back end of last year and early into this year when we had exactly the opposite effects, we had favorable mix impacts and we had very good -- and we had reasonable inflation recovery. So I think those are the big reasons into 2023, I think all that normalizes but off a lower base. So I think once the seltzers are out of the story, I mean they're not completely out of the story, they're still low teens of our business, but once you're not anticipating that growth, our mix will be more stable. And therefore, I think we'll see a more normalized relationship between volume growth and profit growth next year across all our regions. And that's also because I think the inflation recovery will be good in Europe and in North America and Brazil, which comes back to the fact that we've done a lot of work this year on inflation recovery mechanisms in Europe to deal with the exceptional energy costs. So that's probably the way I'd characterize it.

Yes. I mean you're right to point out, there's a bit of lumpiness in terms of Q2, it was strong Q3, weaker Q4 projected stronger again. I think a couple of reasons for that effect. We did take some curtailment activity in Q3, some short-term curtailment activity to rightsize our working capital position, our inventory position, that's slightly more costly to do in terms of fixed cost overhead absorption short-term than it is when you do it on a more planned basis as we will for '23. And I think the other key topic is the inflation recovery conversations in Europe with some of our mainstream customers have largely kind of crystallized through their budget season in Q4, including our recovery for FY '22. So we will get the benefit of that coming into our Q4 performance.

And as you think about inflation recovery next year, maybe more specifically, in Europe, obviously, the energy costs likely are going to be up significantly just as a function of hedge roll-off and where prices have gone. But on the other hand, you had pretty sizable PPI escalators and protection, where I think German PPI was up 43% last month or something. And I assume you can't capture all of that. But to the degree possible, can you kind of help us understand a little bit of the price cost deltas maybe specifically in Europe next year? And what type of contractual protection you have based on where we stand today? I think that the PPI, you actually know what it would be because I think it's in September and then reset the channel. So...

No, that's right. So yes, so we have line of sight on PPI rates that we're passing through at this point. We had line of sight on our costs and what our suppliers are passing through to us. And we also, very importantly, have line of sight of our energy costs for '23 because we're almost fully hedged in Europe for 2023 now. And so all of that is being dealt with the customers. So the PPI mechanisms we think are going to match effectively the cost inflation ex energy. So we think that's a good match. And we've split out energy into a surcharge mechanism with customers because it's such an exceptional period. And we were not confident earlier in the year that the energy and the PPI would exactly match given the PPI mixes can be for very different industries with different mix of energy. So we decided that the right way to go about that was to split that out. And it's also for us a fair and equitable way to discuss it with customers that it's an exceptional event. It's a war. While it's in, it's passed through and then when it comes out, it comes out. So we don't have any remnants of it once the energy price resets. So when we add all that up, we look like we get good recovery. We match the cost increases that we see in '23 with the inflation pass-through clauses that we have in '23.

And would you say the majority of your accounts now have some form of energy protection in terms of the escalator or...

Yes, all -- certainly, all the big accounts, obviously, with smaller customers, you tend to be more just a straight price model. But with the big customers now, we're heavily on that kind of energy surcharge. Some have said they don't like that, but most have recognized that actually that is a very fair and equitable way to deal with the situation.

And then obviously, you've cut the growth CapEx pretty significantly this year from where you were. I think it was maybe $1 billion or $900 million to start the year. I think you're down to $500 million, now, the number is...

Yes. That's $600 million.

$600 million. And you think that will fall again into '23. So maybe just talk about the decisions around that and then you've also discussed shutting down and mothballing some capacity. So we're -- based on how you see '23 today, what do you think your implied utilization rate kind of on your business would be maybe relative to this year? And then the CapEx program that you're contemplating significantly less, then should we think about the long-term EBITDA targets reflecting some moderation as well?

Ollie, do you...

Yes, maybe I'll take that last one and -- but I think the thing I mentioned at the beginning is that 80% to 90% of the growth program capital will be spent and projects delivered by the end of next year. So we're phasing the 2 remaining greenfields in Europe and in Brazil. But majority of what we said we'd do, we have done, and therefore, the EBITDA potential of the business is still there. Now there's some drags relative to the original projections. We've got a big FX drag relative to the original projections with the decline of the euro. We have a drag of mix with less hard seltzer at the higher margin levels in the mix. But fundamentally, the growth capability of the business on EBITDA will be in place at the end of next year. So then the question will be at what speed does the market grow into that capital. But do you want to comment on that?

Yes. No. In terms of BGI, we've still got projects that we will be closing off in the first half of next year that relate to work on this year, all the cash timing of the payments will fall into next year. So there will still be a chunk of BGI spend next year will be significantly reduced from this year, but you'd expect to see that go down further in 2024. And as we grow into that capacity that we've put in, clearly, that will create a virtuous cycle for us in terms of operating cash flow and actual free cash flow once you think through the CapEx position because that will be fairly level set at that point.

And when we think about demand this year, obviously, hard seltzer was an incredible phenomenon going from 2% to 10% of the beer market relatively quickly. We haven't seen anything like that, I think since like the 1980s like beer craze. And obviously, you overlay that with COVID-related demand. It's a perfect storm for something that probably is a generational event in terms of can demand. And now we're kind of normalizing off that. So I don't think it should be that surprising that anyone -- it's not unexpected we see lower volume growth this year, maybe it occurred -- recency bias occurred quicker. But maybe you can address just kind of the longer-term secular trends you still feel that the market is in pretty healthy shape and maybe discuss some of the higher-growth verticals, it seems like energy is still growing well, there's still interest in still water. It seems like you actually had a good quarter in CSD last quarter. So what are your customers telling you? I mean it seems like, obviously, everyone maybe is dialing it back a little bit, but...

No, I think the seltzers are growing 200%, 300% through to 2019 and then they grew 200% in 2020. And what part of that was going to be -- what part of that was seltzers was hard to disentangle, I think. And we certainly didn't expect and nor did anyone else, the reversal that happened to be at that extent. I think everybody expected a flattening of the curve, but not a reversal of the curve. So that was -- that did take us by surprise. And then the inflation obviously has come in and meant that there's a lot of retail price increases that have muted volume growth on the core categories, the mass beer and the carbonated soft drinks. But the things that our customers are telling us and that we've talked about back and we still strongly believe in the sustainability credentials of the can is still absolutely intact. I think it's the most highly recycled beverage packaging and highest recycled content rates. It funds a lot of recycling systems because there is value in getting used beverage can back through the system, because if you make aluminum again, you save a lot of energy, and that's also good for our emissions targets. And so that recyclability is permanent, but material is still a huge thing that with what happened in, say, 2017, 2018 around plastic, essentially in North America, the big [ CSD ] players have rebalanced their portfolio towards cans, and they're not fully -- they're clearly still big PET users and will remain so. But to get to their targets, their ESG targets, the reduction in virgin PET targets, they do need to fill more in cans and they have that capability because they have can filling line. So they don't need to invest in order to pivot that portfolio between PET and can. So they've rebalanced, and that means that coming into this year, one of them tells us that they expected very high single-digit growth in cans percentage and I think they did. That wasn't anything that was just to make sure we cover them, I think that we saw that. And until the price rises for can, I think that's what they're aiming for. And that's why we believe in this low single-digit forecast in North America, because if you look historically, North America was dragged mainly by CSD. [ They'd have ] some growth, there's a lot of innovation, more than 80% of innovation now goes into the can of all beverage innovation. So those new products are going to cans. You've got other categories in growth like you say, energy has been very strong again this year and has been very resilient to the recent price rises. So the drag was always carbonated soft drinks. Once that's a positive, then we get a more normalized growth market, just like we see in all our other markets, that Europe also is a very long-term growth market in beverage cans. We talked about it yesterday at the Citi Conference that Germany is very underpenetrated in terms of can. There was some deposit legislation there that the can was still recovering from that. So you get growth in Germany every year. We're #1 in Germany. You get growth in other categories where the energy sector is still very strong in terms of liquid growth. Eastern Europe has been higher growth historically. So this idea of a 2%, 3% market, we had that for 20 years in Europe, and that is even much higher than the 2018, 2019, 2020 period. So all we're doing is forecasting it back to its long-term growth trajectory, which could be a conservative estimate, [indiscernible], also the glass business probably under some pressure next year with the energy costs [ given to us ] in Europe. So both those -- both North America and Europe, we see as very likely low single-digit markets could be a bit higher. And then there is a big long-term switch out of 2 way packaging into one way, very little one way glass, so it is mostly [indiscernible]. So we think mid-single digits, again, of very soft comps this year is very realistic. So we're back to more normal operating conditions. But with these tailwinds that mean that we don't have the drags that held the industry back in North America in the early part of the last decade.

And maybe if you talk about Brazil for a second. I mean it does seem like there's good long-term growth there to your point. But it's been very volatile this year, right? I think there's some hope that World Cup confuse things, but the economy there is still a little bit weak. So maybe just kind of discuss, a, your positioning in Brazil, and if you can discuss kind of recent trends [indiscernible]?

Yes. No, we're well positioned. One thing we did and signal through the SPAC process is we were diversifying our customer mix, and one of the customers is diversifying their supply mix with us, and we've been over concentrated. So that was something we wanted to do strategically and came also off the back of our glass metal positioning as a group, it's an important positioning with the big brewers. So we gained a bit of share in Brazil. The market has suffered for the inflation. So when a devaluation of the real to the extent there is, that can is priced partly in dollars because the metal and some of those materials is priced in dollars, so you get a significant inflationary impact on cans. And that has damaged demand and the consumer has been under pressure generally. There's been very little COVID support, if not none, unlike Europe and North America. So we didn't come out of COVID with consumers having good savings rates. We have people actually struggling through that period. So that definitely damaged. We had the carnival down last year because of COVID. And then we have -- and we're always skeptical when our team talk about the weather. But it doesn't matter in Brazil, there's a lot of cans consumed in outdoor occasions, beach occasions. And so unfortunately, having a poor weather summer again at the moment, and we definitely had it last year. And then so we're not seeing the World Cup bump that comes from [indiscernible] occasions at the moment. I mean, ticked up a little bit in the last couple of weeks and maybe it will come through. We're just going into the real summer season. And so let's hope we get a good December, January. But again, we see the long-term fundamentals of that market very positively for beverage cans.

Appreciate it. And then with respect to Europe, it seems like there's more public policy support or the shift away from plastics and recycling schemes that aren't as well developed in the United States. And among the industry sort of overall, we've seen a lot of new announcements, can announcements in Europe over the past 12 months. So it seems like Europe is actually now starting to reflect maybe more higher whereas the U.S. is kind of moderating. I mean maybe how would you characterize the European market? In terms of -- and then in terms of your strategic positioning in Europe, how do you kind of compare with your peers? And what would you say the outlook is?

Yes. So I think the European market is a fundamentally strong can market, some of the reasons I talked about German recovery, you've got very strong energy growth in the liquids. And then from 2018 onwards, as you say, we saw a lot of announcements around new can filling lines off the back of the sustainability study. So both the big players in carbonated soft drinks were pushing their growth investment towards can filling lines as opposed to PET, and then other players were following suit on the innovation side as well. So as I say, we had [ 5%, 6%, 7% ] growth in Europe coming into the pandemic. Now what's hard to call in 2023 is simply the economic impact of this very high energy pricing environment. So the consumer will be impacted by that for sure going into the winter. So it's hard to call exactly how that impact their overall spending and then their spending on cans because it may pull back more of their holiday spending or their advertising spending or maybe come back more into beverage cans. We're not absolutely sure yet, [indiscernible] low single digits because we think that's a long-term growth rate for the can, which takes account of all these puts and takes. We have a very strong position across Northern Europe. So we're #1 across the U.K. bev market and Germany. We have [indiscernible] position and a position in Southwest Europe and South of France and Spain. And those Northern markets have been traditionally good growth for cans. U.K. grew very strongly in 2019, 2020 [indiscernible] COVID, but in 2019 pre-COVID. Germany, I talked about, and Benelux is also a big center for co-packing, there was some very innovative brewers. So we also think the Benelux is in good shape. So we're in a good position for the growth in Europe we think. We also have no Eastern Europe exposure, which at the moment is -- last year and the year before, that didn't look so good because a lot of growth was going on in Eastern Europe and Russia, but obviously, this year that's helpful to us in a defensive sense.

And then it seems like you are expecting better price cost positive operating leverage next year, but to the extent that we do go into recession or the volumes still come through, can you talk about maybe from a cost perspective, tactically things you could do to help preserve margin? And then just within your contract structure, I know that you have take-or-pay agreements and certain things that could help prevent volume loss, too?

Yes. Maybe I'll talk about the contracts and then I'll ask to you, David, on the cost story. So we do have a range of contractual protections from sort of volume rebate type structures right through to take-or-pay and sort of legally enforceable minimum volume protections. And we will be – we're unfortunately because of what's happening with volumes having to have those conversations with customers. So there is some degree of protection. And I think the big protection that's coming '23 versus '22 is I think there's a much better line of sight now on the volume story compared to when coming into 2022. If you think, again, I didn't see the inflation this time last year, it was all being termed transitory. I think they didn't see the hard seltzer picture. I think they didn't see a war in Mainland Europe. So a bunch of things happened that were really not visible to our customers now, [indiscernible], there is a clear line of sight through on the volume story, which we're going to be operating again within the plus/minus area that a volume rebate actually is very impactful because make sure you hold to that pricing. If they don't get there because their pricing increases significantly. So I think those protections are in place and I think we just have a much cleaner view. The stocks are out of the system. That was another drag in '22. A lot of people have bought imported cans to cover themselves what they thought was going to be a big year, then when it wasn't a big year, they had to work through all those stocks, and you certainly saw that, and it's been commented on in North America. So all of that gives us a much cleaner read, I think on '23 volumes with those protections. Do you want to give color?

Yes. And if we move on to costs, I think following that theme, the greater certainty on the forecasting side actually helps us with operating cost efficiency because we're able to plan better where we need to take a term on activity how we do that on a long-term cost-efficient basis. We get much more certainty with operating at utilization rates in the low-90s, which is a comfortable place to be. Actually, when we were in kind of supply deficit operating at high-90s, almost 100% in some markets, it's actually really inefficient because freight runs and all that sort of thing you're pulling through. So we think we can do a lot of good work in the manufacturing cost area over the next year off the back of a more certain outlook and footprint. That benefit will, however, be slightly compromised by the fact we're holding on to much more -- a much higher capacity base, and we're still growing into that capacity base. So we think we'll have some fixed cost overhead absorption headwind that moderate some of the gains that we would otherwise get from that manufacturing cost efficiency, but that as we grow into that capacity, that will dilute the fixed cost overhead absorption provide a virtuous cycle for us into '24.

And maybe we could pivot to capital allocation. Obviously, you've kind of changed up your strategy with respect to that year-to-date, now a very healthy dividend yield out back the buyback, you still have a very meaningful level of buyback. Maybe just talk through kind of how you see capital allocation going forward as you start to cycle more down to CapEx, EBITDA goes up? And tactically, is there anything that you plan to change or...

Yes. Look, I think what we've been very clear with the market is that with 4.5x leverage, we think that we'll be there next year. We've got $1 billion of liquidity. We're going to be mindful of our balance sheet position. There's still some uncertainty in the position and we want to kind of hold the buffer while we see that. We're dialing down the business growth investment, but we're saying that dividend at $0.10 a quarter is fully sustainable. So they are the 2 clear plans of change. I think on the share buyback position, we did approximately $35 million of share buybacks through to the end of Q3, having started at the -- in June. But we've paused that while we see where we go to with liquidity and the buffer and our leverage. And so we will use that as a toggle activity depending on where our leverage looks like it's going to come out to at the tail end of next year. So for the moment, you can probably assume we will revisit that authorization, the authorization we have is in place, that $200 million is there through to the end of '23. But the likelihood of enacting that through to the first quarter is probably low, but we will start to look at that, at that stage as we get a clear path through our summer sales plan and see kind of what's going through at that stage.

Okay. And then maybe just on sort of supply chain and sourcing, obviously, metal availability in Europe has become more acute with some smelters being curtailed. I know, obviously, a lot of the can sheet substrate is made from recycled UBC. But maybe you can just talk to, there's been magnesium issues that kind of come up again, and one of the can sheets or can suppliers had an issue. So can you just talk through some of those dynamics, how do you feel in terms of your can sheet, just your sourcing going into next year? And are you be able to pass on price for some of these things like magnesium or whatnot?

Yes. We're very secure, I think in terms of supply next year, the supply chain is in good shape. There's relatively little smelting in Europe. So although there are announcements about curtailment, it's a very small proportion of what goes into manufacturing coils, and as you said, it's a big used beverage can component. And then as the expectations of the market have dropped down, actually, the supply chain was being geared up for a slightly higher sales. So you're actually seeing that we're releasing some of the pressure, I think on coil supply next year in Europe. So yes, we have no concerns there. Similarly, North America in good shape. Ocean freight rates are dropping. So it's also helping imported coils from the Far East to the economics. So those are improving. So overall, we see the picture evenly secured for '23. We did pass through magnesium costs because those were just a completely exceptional event. So they came to us and we passed those through. They have moderated somewhat now though not completely. But so yes, we have managed to generally deal with very exceptional cost increases like that and then the PPI, we've seen covering the other cost increases.

And in general, from your inventory levels and your customer inventory levels, do you feel like those are going to be at a pretty normalized position by the end of this year? I know it's kind of hard to tell on a customer basis.

No. I think we are seeing that now. So we're seeing much more normal ordering patterns. We had customers in the first half of this year ordering half their normal volumes because of inventory positions they'd built. I think if you put people on allocation for 3 years, they do take action to cover themselves. And so they did bring in a lot of imported cans and those are expensive cans that they had to work through. So we think most of that is flushed through the system now by the end of the year. Everybody has also been able to adjust their overall sales position and work that through the supply chain. So we think '23, there's a reasonably clean picture.

And you addressed this a little bit earlier just in terms of your -- some of the larger consumer beverage companies needing to pivot more away from plastic to meet some of their circularity targets. But it seems like we haven't seen really wide-scale conversion of PET water yet. You've seen a little bit maybe more on the CSD side. So are you seeing any headway there? It seems like there's maybe a little bit more innovation that needs to be brought on that, but...

It was always -- yes, it was always the harder one. So [indiscernible] the utilized can filling lines that you couldn't fit from one day to the next, they knew what it was like to filling cans. They've done all the technical and laboratory work to make sure they understood flavor profiles. They're very [ comfortable ] with the can, and consumers understood the can, their channels understood the can. So that was an easy pivot. Whereas for a still water player have never been in cans, there were lots of things to work through in terms of again, taste profile, sizes, replaceability, lots of question marks, and plus [indiscernible] very large 1.5-liter bottles that don't immediately convert. So we always knew it was the most difficult. They've got a very big invested capital base in PET filling and [ non-in cans ] that they need to start to move towards. So what we've seen, I think is the incumbents rather slow to move, pushing down the recycled PET route even though that's challenging. And what we see now is an increasing number of challenger-type brands going after the space with the most successful so far being Liquid Death really growing very fast off the back of a very interesting marketing proposition. And that's what we think will happen, as those brands will come in, take a position and then the incumbents will then need to respond, particularly in certain segments of the market, premium segments, some of the on-the-go segments of certain regions. And that may be then supported by regulatory pressure as certain states in the U.S. or the European Commission push for reductions in overall single-use plastics. So we still see good growth coming in that space. We were always a little bit in the middle between the real [indiscernible], but we still think middle of the decade, there's a good amount of still water that will be filled in cans.

Great. Any questions from the room. Okay. We're almost at time. Do you have any closing remarks you'd like to...

No, look, we appreciate the [indiscernible]. As I say, we had a challenging Q3, but we're looking forward to, as I say, profit and volume growth into 2023, and we think the fundamentals of the story are intact. So it's just a timing thing from our perspective, and we look forward to updating people on that journey.

Great. We really appreciate your attendance. Thank you.

Thanks.

Thank you so much. Thanks, everyone.