In yesterday’s post, I wrote about the Materials sector as a segment of the economy that seems have started to attract the interest and attention to institutional investors. Sector rotation is an approach to market analysis that suggests that if you want to find good investments in any market, it’s a good idea to pay attention to where institutions – mutual funds, investment banks, and insurance companies, to name just a few – are putting their money to work for them.
The average investor really doesn’t have the capital to influence the market, or even a single stock alone; when you consider that most stocks trades hundreds of thousands, or millions of shares per day, the positions that most investors work with really aren’t enough to make analysts sit up and take notice. Institutions are a different story, though, simply because they have hundreds of millions of dollars – or in many cases, billions – in investing capital to keep working for them. That means that when they decide to take a position in a stock, it’s usually big enough, even when it gets spread out over time, to make the market pay attention.
Intermediate, and even long-term trends are often driven by the shift and flow of institutional money from one sector to another. I like to use an elephant rumbling through the jungle as a metaphor for the logic behind sector rotation. The elephant represents institutions; when an elephant thunders through the jungle, there is little that can stand in its way; trees topple and animals scatter out of the monster’s path. Average investors, on the other hand, are like flies in the same jungle; they might want to get to the same place the elephant going, but they simply don’t have the strength or energy to get there. If the fly is smart, though, it’ll find a comfy perch on top of the elephant, and then hang on for the ride. In the same way, paying attention to sector rotation is a good way to try to figure where institutions are putting their money, no matter whether the broad market is going up or down. The direction of sector rotation, in or out of different segments of the economy can give you a way to identify places you might want to think about putting your own money to work for you, or possibly to sector you’d be better off avoiding right now.
Yesterday I outlined my opinion of WestRock (AVY) a Materials company that specializes in paper and packaging solutions. If you like the idea of sector rotation, you’d be smart to keep an eye out for other stocks in the Materials sector that might offer a similar kind of opportunity as what I think AVY offers right now. One of AVY’s contemporaries is Avery Dennision Corp (AVY), a company that operates in the same sector and industry, but with a somewhat different focus. This is a mid-cap stock that has some interesting elements working in its favor, and along with the entire sector, has been following an extended downward trend since early this year. As of yesterday’s close, the stock was nearly 25% off of the all-time highs it saw in January above $120. That’s a big drop that saw more than two-thirds of that drop come in just the last six weeks. Does that mean that it is another great value opportunity to pay attention to in a sector that appears to be gaining some positive momentum in an uncertain market? Let’s take a look.
Fundamental and Value Profile
Avery Dennison Corporation (Avery Dennison) is engaged in the production of pressure-sensitive materials and a range of tickets, tags, labels and other converted products. The Company’s segments include Label and Graphic Materials (LGM); Retail Branding and Information Solutions (RBIS), and Industrial and Healthcare Materials (IHM). The Company’s LGM segment manufactures and sells Fasson-, JAC-, and Avery Dennison-brand pressure-sensitive label and packaging materials, Avery Dennison- and Mactac-brand graphics, and Avery Dennison-brand reflective products. The Company’s RBIS segment designs, manufactures and sells a range of branding and information solutions to retailers, brand owners, apparel manufacturers, distributors and industrial customers on a global basis. The Company’s IHM segment manufactures and sells Fasson-brand and Avery Dennison-brand tapes and fasteners, Vancive-brand medical pressure-sensitive adhesive (PSA) based materials and products, and performance polymers. AVY has a current market cap of $8 billion.
- Earnings and Sales Growth: Over the past year, earnings increased a little more than 15%, while sales improved almost 5%. Growing earnings faster than sales is hard to do, and generally isn’t sustainable in the long term, but it is also a positive mark of management’s ability to maximize its business operations. In the last quarter, however, earnings decreased a little more than about 12.5%, while sales dropped 5.1%. The company operates with a margin profile that improved from 4.3% in the past twelve months to 8.5% over the last quarter.
- Free Cash Flow: AVY’s Free Cash Flow is adequate, but unimpressive given the stock’s market capitalization, at about $212 million.
- Debt to Equity: AVY has a debt/equity ratio of 1.24, which is higher than I like to see but not unusual for stocks in the Materials sector. The company’s liquidity, frankly is a concern, with cash and liquid assets of about $218 million in the last quarter versus long-term debt of almost $1.3 billion; however their balance sheet indicates that operating profits are sufficient to service the debt they carry.
- Dividend: AVY pays an annual dividend of $2.08 er share, which at its current price translates to a very attractive dividend yield of about 2.25%.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for AVY is $12.08 per share. At the stock’s current price, that translates to a Price/Book Ratio of 7.65. The stock’s historical Price/Book ratio by comparison is only 5.38 and puts the top end of the stock’s long-term price target at around $65 per share. AVY may be down since January by nearly 25%, but it is still nearly 30% above the level the market has historically treated the stock as being fairly valued, which means there is quite a bit of downside on this stock looming. Considering that the fundamentals for AVY are decent, but mostly unimpressive, this looks more like a value trap than it does any kind of decent bargain.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: AVY’s downward trend since late January is easy to see. That trend accelerated in a big way in early October as the stock broke down from $112 per share to a 52-week low around $86 per share. From that point, the stock has rallied a bit, and appears to be consolidating in the $91 to $93 range. It wouldn’t take much to push the stock back below $90 to retest its 52-week lows, however, and even the stock does rally, it has its next most likely just a few dollars away from the stock’s current price, at about $97 per share.
- Near-term Keys: A short-term bullish trade is ver speculative right now, and will continue to be unless the stock can push up to about $100 per share. That is a pretty good price level that could signal the long-term downward trend is about to reverse. A much higher probability set up will be seen if the stock breaks down again; a drop to $85 should be taken as a sign the downward trend will keep pushing the stock even lower, with the next support level somewhere between $76 and $78 per share. That could be a good opportunity to short the stock or buy put options. The value proposition just isn’t there for AVY right now, and won’t be unless and until the stock drops into the low-$50 range. That’s a price level the stock hasn’t seen since early 2015.