Global packaging company Amcor Limited (ASX: AMC) and retail behemoth Woolworths Limited (ASX: WOW) both cater to the fast-moving consumer goods industry, but one has a better outlook than the other.
Here are four reasons why I like Amcor right now.
- International exposure
Amcor generates 95% of its revenues outside Australia. The company's client base comprises many of the major multinational consumer products companies, so when they move into new, emerging markets, Amcor follows them. This provides investors with additional exposure to the huge growth in the middle class across Asia and South America.
Of Amcor's revenues, 30% are derived from emerging markets, the sweet spot as far as growth in packaging use goes.
Source: Company reports
- Strong returns and cash flow
In FY14 Amcor reported strong returns with a return on equity (ROE) of just over 24% and analysts forecast this to move beyond 30% over the next few years. It also generated free cash flow post dividends of over $300 million, providing management with the flexibility to continue to buy back its own shares.
- High barriers to entry with strong market positions
Amcor's scale allows it to fractionalise costs across a large asset base, making it extremely difficult and costly for competitors to replicate. Amcor is the global leader in many of its key product segments and it spends a lot of money on research and development to maintain its leadership position.
- Defensive end markets
Almost all of Amcor's revenues are generated from the highly defensive and stable end markets of food, beverage, healthcare, home and personal care and tobacco packaging industries. These industries tend to be far less affected by economic volatility than most other industries.
In contrast, there are four reasons why I won't be rushing to buy Woolworths right now.
- Downgrade cycle
As we see time and time again, the first downgrade by a company in transition is usually not the last. Remember Coca-Cola Amatil Limited? Given the size and nature of this business, a small downgrade is quite meaningful and any future downgrades are not currently priced in by the market.
- Management turnover
This is a qualitative factor but it can sometimes tell investors a lot about the issues facing a company. Woolworths has recently experienced high levels of turnover amongst its senior management – this is never a good sign.
- The "M" word
Everyone knows the issues facing Masters right now and it's hard to see what will turn its performance around. Let's face it, Woolworths is a world-class supermarket operator. Unfortunately, its track record outside of food and grocery is less than stellar…does anyone remember its disastrous ownership of Dick Smith Holdings Limited? It took Wesfarmers Ltd (ASX: WES) over a decade to get Bunnings up and running profitably and it had extremely limited competition at the time. I am somewhat surprised Woolworths did not decide to test the Masters format first because now it appears Masters may be "too big to fail".
- Discount disruptors
The discount supermarket chain Aldi has an excellent track record in disrupting incumbents in overseas markets. Why will it be any different in Australia? A good case study comes from Europe and the French supermarket chain Carrefour SA. It was generating EBIT margins of 3.9% (well below Woolworths' food, grocery and liquor EBIT margins of 6.98% in FY14!) prior to the entry of Aldi and now the margin sits at 2.9%. This may not seem like much, but to a business the size of Carrefour, it has dramatically impacted earnings. I can only imagine what Aldi management must be thinking when they see Woolworths' EBIT margins!
Foolish takeaway
Don't get me wrong, Woolworths is a good supermarket operator; however, in my view I think its shares may tread water until some of these issues are resolved. In contrast, Amcor has numerous appealing characteristics. Its shares look to be a good place to hide during times of market volatility and they should also benefit when markets are doing well given its exposure to growth markets.
