Avery Dennison EPS Lags, Revs In Line

Avery Dennison Corporation (AVY - Analyst Report) reported adjusted earnings per share (EPS) of 56 cents in the second quarter of fiscal 2012, a 7% decline from the 60 cents delivered in the year-ago quarter and falling short of the Zacks Consensus Estimate of 54 cents.

Including restructuring costs and other items, EPS from continuing operations was 49 cents in the quarter compared with 50 cents in the year ago quarter.

Total revenues dipped 0.8% to $1.53 billion from $1.54 billion in the prior-year quarter. Revenues were in line with the Zacks Consensus Estimate.

Cost of sales for the reported quarter improved 1.4% to $1.13 billion. Gross profit increased 1% to $399.8 million from $396.4 million in the prior-year quarter.

Marketing, general & administrative expenses were $292.7 million versus $283.3 million in the year-ago quarter. Adjusted operating income from continuing operations decreased to $107.1 million from $113.1 million in the year-earlier quarter. Operating margin contracted 30 basis points to 7% in the quarter.

Segmental Performance

Total revenues in the Pressure-sensitive Materials segment remained flat at $1 billion. Increase in Label and Packaging Material sales was offset by a decline Graphics and Reflective Solutions. Adjusted operating profit inched up 1% to $91.4 million in the quarter with operating margin expanding 10 basis points as benefits from higher volume offset higher employee-related expenses, including incentive compensation.

Total revenues from Retail Branding and Information Solutions declined 2% to $388.6 million from $396.5 million in the year-earlier quarter due to low demand from retailers and brands in the U.S. and Europe. Segmental adjusted operating income also decreased to $20.7 million with adjusted operating margin contracting 160 basis points to 5.3% due to wage inflation, partially offset by productivity initiatives.

Other specialty converting businesses segment reported net sales of $134.5 million, down 5% from $142.1 million in the year-ago quarter. Adjusted operating profit however improved to $4.8 million from $4 million in the prior-year quarter. Operating margin expanded 80 basis points to 3.6% in the quarter as higher volume and productivity initiatives more than offset higher employee-related expenses and restructuring costs.

Financial Position

As of June 30, 2012, cash and cash equivalents of the company were $161.4 million versus $190.7 million as of March 31, 2012. Long-term debt remained flat at $703 million as of June 30, 2012 from March 31, 2012.

Cash flow from operating activities was $41 million in the first half of fiscal 2012 compared with $95.2 million of cash used in operating activities in the first half of fiscal 2011. Avery repurchased 2.4 million shares during the quarter at an aggregate cost of $70 million.

Avery has initiated its second phase of restructuring initiative that is expected to be completed by mid-2013 and reduce costs across all of its segments. More than $100 million in annualized savings is estimated from this program. However, the company anticipates that it will incur restructuring costs of approximately $55 million 2012 and around $25 million in 2013.

Outlook

The company has narrowed its adjusted EPS guidance to a range of $1.90 to $2.05 from the earlier guidance range of $1.80 and $2.15. Free cash flow from continuing operations is expected to lie between $280 million and $310 million in 2012.

Our Take

Avery generates one third of its revenue from Europe and given the weak demand in the region, we maintain a cautious stance. Furthermore, rising raw materials prices, negative currency translation and slower growth following the sale of the Office and Consumer Products business remain headwinds.

The company has aggressively cut costs in the past three years, to the tune of nearly $160 million in expected annual savings. Additional restructuring will help reduce costs. Further share repurchases and dividend hikes could fundamentally improve investor sentiment.

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 competes primarily with Bemis Company Inc. (BMS - Analyst Report) and 3M Co. (MMM - Analyst Report).

We maintain our Underperform recommendation on Avery Dennison. The shares of Avery Dennison are currently maintaining a Zacks #4 Rank (Sell) over the short term that corresponds with our recommendation.