2023-10-30 10:30:00 ET
Summary
- Ardagh Metal Packaging meets Q3 EBITDA guidance, leading to a positive market reaction.
- The company reduced its full-year adjusted EBITDA target, slightly disappointing but not negatively impacting the market.
- Ardagh's dividend is sustainable and fully covered by sustaining free cash flow, with plans to reduce debt and improve debt ratios.
Introduction
While I am still confident in Ardagh Metal Packaging’s ( AMBP ) future, I am most definitely not a very happy shareholder. Questions about corporate governance (issuing 9% yielding preferred shares to its main shareholder) and missing expectations have caused the share price to slide from above $10 to less than $3. And pretty much after every quarterly update, the share price fell a little bit more. It is however possible an inflection point has now been reached . Ardagh met its Q3 EBITDA guidance but had to slash its full-year EBITDA target. Fortunately the market reacted well as it appears to be focusing on the positives for the first time.
Finally meeting its guidance
The company initially guided for a Q3 adjusted EBITDA of $170-175M and with an adjusted EBITDA of $171M , the company did meet its guidance, and that was met with a sigh of relief from the financial markets. The margins are finally recovering as compared to Q3 2022, the revenue increased by 10% while the adjusted EBITDA improved by 22% on a reported basis. This improvement mainly came from its European activities, where the adjusted EBITDA jumped by 76%.
Looking at the income statement, the total revenue indeed increased to $1.3B, resulting in a gross profit of $164M before exceptional items and approximately $159M after exceptional items. The operating profit more than doubled compared to a year ago, mainly because the total amount of exceptional items is finally decreasing: whereas Ardagh reported just $28M in operating profit in Q3 2022, it was able to boost this result to $61M in Q3 2023 .
The net finance expense normalized but due to the derivatives and for instance the value of the earn-out shares, the total amount of finance expenses will remain volatile. The pure interest expenses on the bonds were $33M for the quarter. The bottom line showed a net income of $17M or $0.02 per share. However, that is the result before the preferred dividend payments and those preferred dividends cost the company $6M per quarter which means the attributable net income was just $11M and that’s what the $0.02/share is based on.
Despite meeting the Q3 guidance, Ardagh has reduced its full-year adjusted EBITDA target. For the final quarter of the year, Ardagh is guiding for an adjusted EBITDA of $158M (which is an oddly specific number and not a ‘range’ it traditionally provides. This means the full-year adjusted EBITDA will come in at $610M compared to the $630-640M it was previously guiding for. That is slightly disappointing, and it is surprising the market didn’t react too negatively to this news.
What does this mean for the cash flows and the dividend?
One of the main reasons why I kept holding on to my position in Ardagh was its generous dividend. The company currently pays a quarterly dividend of $0.10 per share and due to the low share price, the dividend yield had increased to around 14-15% and even now, at $3.25 per share, the dividend yield is still in excess of 12%.
Of course, it is important to check if the dividend is sustainable. As you were able to read in my previous articles on this company, the dividend for sure wasn’t covered based on the reported cash flows but was close to being covered if you’d look at the sustaining free cash flow. Fortunately the company’s expansion plans are now almost complete and the committed capex has been spent. This means that from next year on, we should see a drastic reduction in the reported capex to just the sustaining capex plus $100M in annual growth capex.
That’s important as this will finally allow Ardagh to start hoarding more cash to strengthen its balance sheet ahead of debt refinancings in the next few years. There is no rush as the low-cost debt only matures from 2028 on (that’s the one thing Ardagh was very smart about), and the fixed rate nature of the majority of its debt is a big help.
Looking at the cash flow statement, Ardagh reported a total operating cash flow of $212M, but the starting point is the ‘cash generated from operations’ to the tune of $215M. Looking at the details in the footnote (see below), we see there was a $53M working capital release which boosted that result.
This means we should deduct the $53M in working capital contributions and an additional $20M in finance expenses from the $212M reported below. This means the adjusted operating cash flow was $149M.
After also deducting the $17M in lease payments, the adjusted operating cash flow was $132M which fully covered the total capex of $83M. The underlying free cash flow result was $43M after also deducting the $6M in preferred dividends from the equation.
While this still wasn’t sufficient to cover the $60M dividend on the common shares (the shortfall was $17M), the conference call provided additional clarity on the breakdown of growth capex and sustaining capex. According to the management, about $54M of the total capex consisted of growth and only $28M was sustaining capex.
This means the sustaining free cash flow during the quarter was $98M and this was more than sufficient to cover the $60M in dividend payments.
Investment thesis
While I am definitely not a big fan of Ardagh paying such a high dividend and while I feel the cash could better be used to either buy back stock at the current valuation or to buy back some of its bonds at a deep discount to par, I am very pleased to see the dividend was fully covered by the sustaining free cash flow. And based on the growth capex guidance for the next few years, the dividend will now also be covered based on the sustaining capex + growth capex projections for 2024 and beyond.
I still have a long position in Ardagh Metal Packaging but as the position is already oversized I am not adding anymore at this point. But the stock is still relatively cheap, although the focus should now shift to reducing the net debt and improving the debt ratios.
For further details see:
Ardagh Metal Packaging: The 12% Yield Is Now Fully Covered