Ardagh Metal Packaging: Stubbornly Maintaining Its 10% Dividend Yield (NYSE:AMBP)

Introduction

I have been following Ardagh Metal Packaging (NYSE:AMBP) since the company went public through a spinoff from the Ardagh Group, which remains the company’s majority shareholder. Shareholders from day one in AMBP haven’t had a lot of reasons to be too happy yet. Yes, the company pays a handsome dividend, but that’s meaningless if you’re sitting on a 50%+ capital loss. As I am a strong believer in the aluminum can business, I continued to average down in the name, waiting for the growth capex to come down to next to nothing as the underlying sustaining free cash flow generated by the company remained strong.

The inflection point will likely be reached this year, as I expect the dividend to be fully covered.

However, I wish the dividend would be cut as the company could use the discretionary cash flow to buy back its debt on the open market to keep its funding costs under control later this decade when the cheap debt will have to be refinanced at higher rates.

A strong start of the year and the outlook for Q2 and FY 2024 are good

Although the company has often been too optimistic when it issued a guidance, it finally appears to be on the right track now, as there are now clear signs the customer destocking phase is now over (or at least slowing down massively). AMBP reported volume growth in all of its markets (with a growth of 11% in the Americas, including a 13% volume increase in North America) while the EBITDA came in ahead of expectations thanks to the higher volumes.

While the total revenue increased by just 1% to $1.14B, the COGS decreased by approximately 1% and this resulted in an increase in the gross profit by almost 10% (AMBP operates in an environment where economies of scale are very important, and as you can see, a 1% change in both the revenue and COGS can have a very meaningful impact on the financial results.

As shown above, the operating profit was just $14M, and after deducting the $35M in net finance expenses, the pre-tax loss was $21M resulting in a net loss of $12M. The $17M in exceptional finance income was related to the lower fair value of the earnout shares and the warrants.

Excluding exceptional items, the net loss would have been $19M. Definitely not good, but my main investment thesis for AMBP was always based on the company’s cash flows, as the company’s depreciation and amortization cost is substantially higher than the sustaining capex. That’s not really a surprise, as building new plants represents a high upfront cost (and thus relatively high depreciation expenses) while the cost to keep the lines running is relatively low.

In the past few years, AMBP has been investing pretty heavily in production growth, but the growth investment cycle is coming to an end and the reported free cash flow will finally start to show the real underlying earnings power of the company.

The cash flow statement shows a negative operating cash flow of $338M.

As you can see above, the starting point of the calculation was the $316M ‘cash used in operations’, but the footnotes to the financial statements provide a nice breakdown of how that negative $316M was obtained. As you can see below, this includes a $423M investment in the working capital position, while it also includes $27M in exceptional items.

Adjusting the negative $338M in operating cash flow for the $423M in working capital investments results in a $85M operating cash flow and about $64M in adjusted operating cash flow after deducting the lease payments. This still includes the $27M in exceptional items, but also understates the interest payments by approximately $20M (as the interest payments on the bonds are paid every six months and not every quarter).

The total capex was $63M which means that the company was breaking even (finally) on the reported free cash flow level but based on the management comments during the Q4 call, only $25M of the total capex was maintenance capex. This means the underlying sustaining free cash flow was a positive $39M, or $0.065/share.

That’s still not sufficient to cover the dividend payments, but keep in mind the first quarter likely will be the weakest quarter of the year.

The company reported an adjusted EBITDA of $134M in Q1 2024 and although that is a 3% increase compared to the first quarter of the preceding year, the best is yet to come. For the current quarter, the company is guiding for an EBITDA of $170M. This means the EBITDA will increase by in excess of 25% on a QoQ basis, while it also represents a 12.5% YoY increase. The full-year EBITDA has now been confirmed at $630-660M.

Using the midpoint of $645M in adjusted EBITDA and after deducting $435M in depreciation and amortization expenses, the EBIT will be around $210M. This should result in the company posting a pre-tax profit close to $40-50M (as I anticipate the interest expenses to continue to come in around $160-165M per year going forward, although this year may be a bit higher due to the financing of working capital variations at a cost of debt of 5.9%). The net income should be around $30-40M, representing 5-6.5 cents per share for the year. If the interest expense comes in a bit higher than anticipated, it is possible the bottom line will show a net result close to zero.

However, during the Q4 conference call, it once again became clear the sustaining capex will be just around $120M this year. And after adding the $85M in annualized lease payments, the total of $205M in annual sustaining capex and lease payments is less than half the depreciation expenses. This means the net free cash flow will be approximately $230M higher than the net income on an underlying basis. This indeed implies a net sustaining free cash flow of $236M for the year (after also deducting the preferred dividends), which represents around $0.40/share.

The capital allocation priority remains unchanged

The strong underlying cash flow means the current quarterly dividend of $0.10 per share will be fully covered. That doesn’t mean I’m very happy with the capital allocation.

After all, the $260M in sustaining free cash flow will also have to cover the anticipated $100M in growth capex, which means the dividend is weighing on the net debt level. While the debt ratio will improve thanks to the higher EBITDA result, I wish the company would spend more attention to debt management.

While, as you can see above, there is absolutely no near-term pressure on the company’s funding as the first bond only matures in 2027, the $3.35B in net debt (excluding lease obligations) represents a multiple of approximately 6 times the lease-adjusted EBITDA. And as all bonds are now trading substantially below par, I feel the free cash flow could be used to buy back bonds below par to accelerate the debt reduction pace. The 2029 bonds (with a 4% coupon) maturing in 2029 are currently trading at just over 81 cents on the dollar.

Investment thesis

According to the management comments on the Q4 call, the strong volume momentum continued into April, which further strengthens the confidence to meet the $170M adjusted EBITDA guidance for this quarter. This also means the total adjusted EBITDA in the second half of the year will have to be $326M to meet the lower end of the full-year guidance and in excess of $350M to meet the higher end of the full-year guidance.

I still have a substantial long position in Ardagh Metal Packaging, and although I’m still not happy with the capital allocation priorities and the questionable corporate governance (the 9% preferred shares that were issued to a related party), I am sticking with my position. The stock is still not outrageously expensive, but I think a lower debt ratio would help to convince the market that AMBP is finally turning a corner.