ACCO - ACCO Brands: Moving To Neutral

Summary

• The company is facing headwinds due to the lower replenishment of inventory by retailers, declining demand in the gaming accessories business, and weakening macroeconomic conditions in the EMEA region.
• The company’s margins should benefit from the moderation in inflation in North America, pricing actions in both North America and EMEA, and cost-saving initiatives.
• I am moving to the sidelines for now and would wait for resumption in revenue growth before becoming more optimistic about the stock.

Investment Thesis

ACCO Brands ( ACCO ) is up ~12% since our last article , in which we termed it as a speculative buy due to low valuation and tailwinds for revenue and EBITDA growth. However, things have incrementally become worse, and the company is facing headwinds due to the lower replenishment of inventory by its retailers, declining demand in the gaming accessories business, and weakening macroeconomic conditions in the EMEA region. These headwinds should more than offset the benefits of the pricing actions and healthy return-to-office trends, resulting in declining Y/Y revenues in 2023. The margin prospects are slightly better, and I believe the company’s margins should benefit from the moderation in inflation in North America, pricing actions in both North America and EMEA, and cost-saving initiatives, partially offset by volume decline. Since my last article, the earnings estimates have gone down and the stock price has increased. The stock is currently trading at a forward EV/EBITDA of 7.03x, which is above its five-year average forward EV/EBITDA of 6.62x. I am moving to the sidelines now and would like for revenue decline to bottom before becoming more optimistic on the stock.

Revenue Outlook

The company is benefiting from solid return-to-office trends. This, along with the strong back-to-school season and pricing actions, benefited sales in the third quarter of 2022. However, these positives were more than offset by the negative impact due to lower inventory replenishment by retailers, reduced sales of gaming accessories in North America, and the challenging macroeconomic environment in the EMEA region, resulting in a decline of 2.1% in overall comparable sales.

Looking forward, I believe the company’s sales in the near term should continue to be impacted by the retail inventory de-stocking challenges, the weak macroeconomic environment in the EMEA region, and declining demand in the gaming accessories business in North America. ACCO’s retailers in North America are de-stocking their inventory levels as they purchased higher-than-usual inventory earlier in 2022 to ensure product availability given the supply chain challenges. The excess inventory levels at its retailers resulted in significantly lower inventory replenishment in the third quarter of 2022.

I expect retailers to remain conservative with their inventory levels in 2023. There is little reason for them to be optimistic about consumer demand given the current weakening macroeconomic environment, and until the inventory levels are rightsized, ACCO will continue to face headwinds from inventory de-stocking .

The gaming accessories business in North America is facing headwinds due to the decline in demand and semiconductor chip shortages. The gaming industry saw a boost in demand during the Covid period. However, with the reopening of the economy, people are spending more time doing outdoor activities. Additionally, the company is continuing to face the chip shortage issue, which is impacting its sales. During its previous earnings call, management updated the gaming accessories’ 2022 revenue guidance to down 15% from its previous guidance range of 11% to 15% as the outlook continues to worsen for this business.

In the EMEA region, the sales volume is declining due to rising inflation, the war in Ukraine, and the energy crisis. The energy crisis is expected to worsen further given the continued geopolitical tensions and increasing Russian isolation. Management is also expecting consumer sentiment to be low in EMEA in 2023 due to these reasons. This, coupled with negative FX impact due to the strong U.S. dollar, doesn’t bode well for the company.

While the company is implementing pricing actions in both North America and the EMEA region, I don’t think it will be able to offset these demand-related headwinds completely, and expect sales to decline in 2023. Further, the current recessionary pressures limit the extent to which the company can raise prices without destroying demand. So my short-term demand outlook is negative.

In the long term, the company intends to transform its business to be more consumer-focused and geographically diverse by investing in innovative products for use in businesses, schools, and homes, both organically and inorganically. But this transformation is still in its initial phases and I need to see management’s execution on this front before becoming more optimistic. Also, I am usually skeptical of long-term plans of management, when the company has high debt levels because it limits the company's ability to invest in its long-term plans. ACCO's high net leverage ratio of ~4.6x net debt to EBITDA ((TTM)) gives me little comfort.

Margin Outlook

The company is experiencing fixed-cost deleveraging in its manufacturing facilities due to lower sales, which is impacting the company’s margins. Additionally, the higher inflation levels related to finished goods inventory, inbound freight, and outbound transportation are affecting the gross margins.

Looking forward, with inflation easing in North America, the benefits of moderation in higher input costs should start flowing through the income statement in 2023. The inflation in the EMEA region still remains high which is impacting margins. The company is taking pricing actions in both North America and EMEA regions to improve its gross margin in 2023. In the EMEA region, the company is reducing its variable labor costs and discretionary spending in response to the lower demand, which should help the operating margins. Management is also aggressive with its cost-saving actions. I am optimistic about the margins given the company’s pricing actions, moderating inflation in North America, and cost reduction initiative, and expect them to offset volume deleveraging, resulting in a modest improvement in margins.

Valuation & Conclusion

One thing which worries me about the company is its high debt levels. The company has a net debt of $1.092 bn which is 4.64x its trailing twelve-month EBITDA of $235 mn . This limits the company’s ability to invest in the business for the long term. Further, if things go south in 2023, this ratio may worsen. The company's valuation is also a bit high right now, with its consensus EV/EBITDA ((FWD)) of 7.03x versus a five-year average EV/EBITDA of 6.62x. While I like the company’s cost-cutting measures as well as benefits from price increases and moderating inflation, I believe it is best to be on the sidelines now till revenue headwinds bottom. Hence, I am moving to the sidelines and have a neutral rating on the stock.

For further details see: