After reviewing narrow-moat beverage can producer Rexam's second-half and full-year report, we do not expect to materially change our fair value estimate of £5.50 per share. The results were mixed, with some positive news offset by some concerning trends.
Starting with the positive points, Rexam (REX) increased its final dividend by 14.7% to 11.7 pence per share, which equates to a yield of around 3.6%, relatively high for the packaging industry. Rexam's attractive dividend yield is also a feature that differentiates its stock from those of its primary beverage can competitors, Ball and Crown Holdings, which prefer to return cash to shareholders through large share repurchases. The balance sheet is in fine shape and should provide Rexam with the financial flexibility it needs to make bolt-on acquisitions and reinvest in the business. Finally, Rexam hit its three-year target of realizing 15% returns on capital employed – a level it aims to maintain in the coming years. We believe this is achievable.
For the negatives, we are most concerned about the outlook for the North American beverage can business, which accounts for about 35% of annual sales and operating profits. Though Rexam posted 11% standard can volume growth in 2013, this was largely due to re-winning soft drink business lost a few years ago and we don't expect regional standard can volume growth in 2014. Meanwhile, North American specialty can volume fell 3% versus 2012. While this was a difficult comp considering Rexam's specialty SLEEK can was launched in 2012, the company expects that the maturing specialty can market will lead to weaker regional pricing and volumes. Russia also continues to be a thorn in the side of Rexam's Europe and Asia, Middle East and Africa beverage can business, with 2013 regional volumes down 17% versus 2012 because of increased competition, government regulations on alcohol consumption, and tepid economic growth.
Political unrest in Turkey and Egypt also weighed on consumer confidence in those markets, with depressed results in the Europe and Asia, Middle East and Africa region. We consider such frontier markets to be very risky with uncertain return profiles, but it will be in unproven markets like these that Rexam has an opportunity to drive long-term growth. The North American, South American, and European beverage markets are now mature, and while they provide good returns and cash flows to Rexam, investments in frontier markets will take an increasing share of capital investment in the coming years in order to generate longer-term returns.
An example of this can be found in Rexam's recent majority investment in Saudi Arabian can manufacturing company, UAC. This transaction, which is expected to close in the third quarter, would give Rexam the second largest market share in the Middle East/North African region after Crown. We expect further consolidation to take place in this region in the coming years.
Finally, we were impressed with the near-doubling of beverage can volume in India this year, albeit from a small base, and think Rexam was wise to be an early mover in this region. Still, it will be many years before the Indian market might have a material impact on results.
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