Avery Dennison Corp.

Avery Dennison (“AVY” or “the Company”) is an S&P 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. We believe it has resorted to reducing key financial disclosures, and more brazen maneuvers to cover-up its weakening performance including understating debts. Notably, Avery has recorded ~$1 bn of restructuring and impairment charges in the past 20 yrs. Recent programs implemented during COVID-19 expose it, not only to lower earnings leverage when global markets recover, but to financial restatement and SEC investigation risk. We find irrefutable evidence that Avery has inaccurately portrayed its 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. We find an alarming pattern that Avery has concealed 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 evaluate our findings.

“It’s Just A Label” According To A Former Employee We Spoke With. This Sums Up Our View That Avery’s Best Days Are Behind It

  • Avery invented the pressure sensitive label category more than 80yrs ago, and our research shows it is a very difficult product to innovate and expand margins. In the case of Avery, a global competitor in labels and adhesives, we find it reports growing Adjusted operating income margins when key competitors report margins are under pressure
  • We believe Avery’s financial reporting defies reality by painting a false sense of a stable / growing business vs. one under multiple pressures. Through the course of our forensic research processes, which included speaking with numerous former senior employees, customers and industry consultants, we identified a number of large headwinds facing Avery, and many classic red flag actions taken in response

Spruce Point Has Identified 10 Headwinds Downplayed, Ignored, Or Never Disclosed By Avery And Its Stock Promoters

  • Pressure to move towards more sustainable solutions: Involves R&D costs to Avery, with no discernable tangible benefit to earnings. Avery stopped disclosing revenues from new product introductions, and in FY 2020 recently stopped disclosing R&D expenses
  • Continued growth of shrink sleeves: Now almost 20% of market share for label technology, growing at the expense of pressure sensitive labels
  • Continued shift toward flexible packaging from rigid packaging: Flexible packages (pouches) don’t require labeling and are resealable
  • Consolidation Among Converters (Avery’s Customers): Private equity rolling up customers, increasing their bargaining power
  • Rigid packaging printing technology: As technology improves to print direct on hard surfaces, it could further displace labels on cans and glasses
  • Insourcing of laminate and coating machines: Larger Avery customers are backward integrating with their own laminate machines
  • Apparel Sales Slowing: Shrinking retail footprint and work from home trend hurting Avery’s apparel business
  • Refillable Food and Beverage Plastics Solutions: Supermarkets experimenting with refill solutions, a negative for bottles, cans and boxes
  • Temporary and Long-Term Cost Cutting And Restructuring: Extreme cost cutting measures made during COVID-19 will look to leave Avery poorly positioned to earnings leverage when global economies recover
  • Unwind of Beneficial Tax Schemes: Aggressive tax schemes now being audited by foreign jurisdictions, which could materially impact EPS

Avery Dennison Showing Multiple Classic Spruce Point Signs of Increasing Financial Strain

  • Pre COVID-19, Avery regularly touted Organic Sales growth, but stopped providing quantification of volume and pricing/mix impact a number of years ago. With extreme and frequently repeated cost cutting and restructuring measures, Avery is claiming that consolidated Adjusted Operating Margins and Adjusted EPS are rising, yet Free Cash Flow hasn’t structurally increased in years
  • Key Financial Disclosures Being Omitted, Notably Metrics Affecting Revenue, R&D Expense, And Debt
    • Innovation is the lifeline of Avery’s business. Former employees tell us that Avery tracks revenues from new product introductions as a key metric. Yet, Avery does not disclose this figure to investors, and last mentioned sales growth from new products in 2013. One former employee was skeptical Avery is getting much of return on R&D investment, especially from sustainable products such as CleanFlake. In FY 2020, Avery ceased disclosing R&D expense in its quarterly filing for the first time
    • Avery stopped disclosing sales return liability, and implemented an accounting change in 2020 which increases credit loss charges
    • Other key disclosure reductions: Operating Lease Costs (stopped disclosing in 2020, leading to understatement of debt), Advertising Costs, Deferred Revenues, and Non-Cash Capex
  • Pension Restructuring And Tax Structuring Methods Becoming More Brazen To Portray Earnings And Free Cash Flow Growth
    • Avery reduced pension liabilities with corporate debt in 2018-2019, but we believe it obscured the tax benefits associated with the restructuring, thereby leading investors to believe its underlying free cash flow was growing, when based on our adjustments, it’s declining
    • Avery hired a tax executive from Greif, a packaging company we successfully exposed in 2015 for its aggressive tax strategies. The SEC later asked Greif extensive questions about its income tax and accounting. Like Greif, Avery has had wild swings in its effective tax rate, and is now warning about audits causing a potential material adverse effect to the business
    • We believe Avery has become so aggressive as to name whimsical subsidiary entities poking fun at the IRS for its ability to reduce taxes
  • Management And Board Turnover Accelerating In FY 2020
    • Five key members of Avery have departed in 2020, notably the VP of Investor Relations (along with the former one and current VP of Finance), SVP and General Counsel, the VP and Treasurer, and Lead Independent Director
  • Returning Capital To Investors Through Dividends And Stock Repurchases Is Falling Well Below Potential
    • After forestalling the dividend increase and suspending share repurchases during most of 2020, Avery reinstated buybacks and increased its dividend in Q3 2020. The dividend increase was just 7%, the lowest increase in years, and buybacks were just $7m. If we are to believe Avery that its free cash flow guidance of $500m is achievable, it could have easily increased the dividend more and repurchased more shares
  • Pivot Back To Acquisitions And Debt Is Rising To Plug The Hole of Evaporating Cash Flow
    • Avery is an “investment grade” rated BBB / Baa2 / Stable by S&P and Moody’s, respectively. We believe the credit agencies are not attuned to the fundamental challenges, and problematic accounting masking its struggles. In fact, Moody’s “Credit Strengths” are subtly being disproved by management, and our forensic investigation. We believe Avery’s Net Debt / 2020E EBITDA is closer to 2.3x vs. 1.9x projected

Biggest Red Flag of Avery’s Stress Is Its Repeated And Growing Restructuring Programs. The Restructuring Charge Accounts Don’t Add Up

  • In the past 20 years, Avery has recorded nearly $1.0bn in restructuring charges (lease terminations, severance charges and asset impairments, ex: goodwill writedowns). Despite all of these recurring charges, free cash flow hasn’t structurally increased
    • In the last 5 years, we estimate negative organic EBIT growth when adjusted for cost savings programs and acquisitions
    • Using the Wayback Machine we find limited evidence that Avery has optimized its physical global location footprint
  • We believe Avery has grown so dependent on restructuring charges to perpetuate growth, that it has pivoted towards accounting manipulation
    • For the first time, Avery modified its recent 2019 10-K Annual Report language discussing its accounting method for restructuring charges
    • In its recent 10-K, Avery restated 2018 restructuring charges lower by 62%, without explanation, leaving its restructuring charge accounts unbalanced by segment. This allowed it to inflate historical Adjusted Operating Income, EBITDA, and EPS while understating financial leverage
    • At the beginning of 2020, Avery expanded its “clawback” language in its executive bonus programs for fraud and intentional misconduct
    • Avery is now warning that with permanent and temporary cost savings measures in 2020 of $65m and $150m, respectively, it expects headwinds as global markets recover. We view this as tacit acknowledgement that it has sacrificed competitiveness to hit short-term numbers
  • Peter Barker, A Fixture on Avery’s Audit Committee And Former Audit Chairman, Is Closely Associated With Many Companies And Individuals The SEC Has Investigated In Relation To Impairment Charges. His Biography Fails To Disclose These Connections
  • Barker has served on the Boards of three companies that have come under SEC investigation, Stone Energy, GSC Investment Corp and Fluor. At both Stone Energy and Fluor, where he served on the Audit Committees, there were full financial restatements and SEC inquires into the recognition of charges
  • Both Avery and Barker fail to disclose his role on the Board at Riverstone Energy Ltd, a poorly performing publicly traded closed end fund in the UK. This connects Barker with his former Goldman Sachs colleague David Leuschen who settled with the NY Attorney General in a state corruption scandal
  • Barker is also closely connected with Jim Hackett. Both individuals served together on Fluor and Riverstone’s Boards. Hackett recently founded Alta Mesa Resources, a SPAC that collapsed into bankruptcy, and is under SEC investigation as it relates to impairment charges
  • Avery’s Board ranks itself lowest on financial sophistication, no surprise to us given our findings that:
    • Management’s annual incentive bonus is tied heavily to Adjusted Free Cash Flow and Adjusted EPS. We believe both figures have been inflated by management through analytically flawed presentation methods and accounting manipulation
  • All Insiders own just 1.1% (880k shares) of Avery – an all time low – and down materially from 2013 when insiders owned 3.8% (3.8m shares)

Poor Risk / Reward With Analysts Having Boosted Targets To All-Time Highs Despite Glaring Signs of Stress And Headwinds Mounting

  • Avery’s end markets and businesses have yet to fully recover from COVID-19 and its cost cutting measures have exposed accounting weaknesses and potential loss of competitive position when a rebound occurs. Yet, sell-side analysts reward Avery with price upgrades to all-time highs
  • The average analyst price target is $146, giving the stock a -4% implied upside. Avery trades at the highest valuation multiple among material and specialty chemical peers despite below average 2021 FCF margins and revenue growth. Avery’s dividend yield also falls well below the industry average
  • Downside catalysts outweigh upside potential. Avery has consistently missed revenue estimates, while beating “Adjusted” EPS estimates through aggressive cost cuts and lower tax rates. Now Avery is warning of foreign tax reviews poses a material adverse risk
  • Avery trades at premium to peers on EBITDA and FCF, both metrics we believe are highly manipulated. At 20x our estimate of normalized FCF, and 8.0x-10.0x normalized EBITDA, we arrive at a price target of $68 – $99 per share or 35% – 55% downside risk

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