Ask the Analyst: Will Amcor lose its dividend aristocrat status?
When consistency becomes constraint.
Mentioned: Amcor PLC (AMC), Betashares S&P Glb H Div Aristocrats ETF (INCM), ProShares S&P 500 Dividend Aristocrats (NOBL)
Welcome to ask the analyst, where members of Morningstar Australia’s equity research team answer questions from the Morningstar community. If you have a question about an ASX company or industry in our coverage, please send it to tyger.fitzpatrick@morningstar.com.
Today’s question focuses on why Morningstar believes Amcor is at risk of cutting its dividend and what this means for investors. Amcor is a global packaging company that has rewarded income investors for years.
At the centre of this debate is whether Amcor’s “Dividend Aristocrat” status can be maintained without compromising its balance sheet. The recent acquisition of Berry Global has stretched Amcor’s financial position through inherited debt. On top of this, tightened cashflow from broader macroeconomic conditions has led to concerns about dividend growth over the medium term.
I spoke with our equity analyst Esther Holloway to better understand the key drivers behind Morningstar’s view, the likelihood and potential timing of a dividend cut and the fallout for Amcor investors. First let’s investigate the origins of the “Dividend Aristocrats”.
From humble beginnings
The “Dividend Aristocrat” concept originated in S&P research publications in the early 1980s. It was originally an analyst curated list in a publication called “The Outlook” highlighting growing dividend stocks.
Following the dotcom crash, investors naturally gravitated towards companies with earnings resilience even during a market crash. The concept eventually formalised into an index of US listed companies with a minimum of 25 consecutive years of dividend growth. The popularity of the Dividend Aristocrat created demand for index tracking ETFs such as NOBL:BATS and INCM.ASX.
The bar for entry for dividend aristocrats is high as it requires navigating multiple economic cycles. To grow distributions during long bear markets requires defensive earnings, a strong balance sheet and disciplined management. These characteristics have been shown to lower the long-term volatility of dividend aristocrats compared to the wider S&P 500 index.
There is a downside to becoming a dividend aristocrat as it changes investor expectations. Investors typically expect a dividend aristocrat to prioritise growing its dividend in the future.
However, past performance is not a reliable indicator for the future and typically 1-2 companies lose their aristocrat status each year. If a dividend aristocrat cuts its dividend, it can lead to forced selling from index backed ETF’s & mandated private funds. It can also be perceived as a negative signal for the income investors drawn to these shares.
Amcor’s dividend consistency
Amcor is the largest global provider of plastic packaging with dominant positioning across the Americas, Europe and Asia. Most of its revenue is driven by food and beverage packaging which is naturally defensive. However, Amcor is also exposed to its customers inventory cycles which fluctuate with consumer demand. This is why Amcor is considered a consumer cyclical business.
Amcor has a long history of increasing its distributions. Prior to 2019, Amcor traded primarily on the ASX and maintained a long track record of dividend growth. The acquisition of Bemis in 2019 saw its primary listing move to the New York Stock Exchange.
Its US listing meant distributions would be paid in USD while Aussie CDI holders still received dividends in AUD (ie. ASX.AMC). Amcor’s inclusion as a dividend aristocrat in 2020 was driven by Bemis, which previously held its own US dividend aristocrat status for 11 years.
The turning point
Despite a strong history of dividend growth, the more recent merger with Berry Global has stretched Amcor’s balance sheet. Esther notes that the Berry acquisition more than doubled the company’s net debt. In response, Amcor is trying to sell assets to ensure it can sustain dividend growth. However, disruptions from the US-Iran conflict and a global downturn in consumer demand raise serious questions about dividend sustainability.
Esther models a 25% dividend cut over the next three years before reverting to growth thereafter. In this scenario, the dividend cut provides some breathing room on the balance sheet to weather the current economic conditions.
Esther believes the only cash levers Amcor can realistically pull are through equity raisings, asset sales or cutting the dividend. Out of the three levers, cutting the dividend would be the least impactful overall given the current economic backdrop. By the same token, a sustained reduction in the annual dividend would result in Amcor’s removal from the Dividend Aristocrat index, breaking the dividend growth streak.
The impact of losing aristocrat status?
A direct consequence of an annual dividend cut would be the forced selling from ETFs tracking the Dividend Aristocrat index. Amcor has a 1.38% weighting in the Dividend Aristocrat index. The largest “pureplay” dividend aristocrat index ETF is NOBL. By approximating the outflows from the NOBL ETF in the event of a cut, it equates to roughly 0.75 days of average daily trading volume for Amcor.
While ETF outflows create short-term price pressure, a sustained decline would likely reflect a fundamental reassessment of dividend sustainability from income investors rather than mechanical selling. While NOBL dominates pure dividend aristocrat ETF exposure, additional global and mandate driven funds would modestly increase the total institutional selling.
The big picture
While Esther forecasts a dividend cut for Amcor, she notes there is still a path for Amcor to retain its current dividend growth. The key is asset sales to free up cash flow and a fast resolution to the US-Iran conflict.
The normalisation of oil prices and a revival in consumer confidence ultimately lessen the likelihood of a dividend cut. Esther expects tough consumer conditions in the US to persist while the US-Iran war continues. Amcor is not immune to cyclicality, and the timing of the Berry acquisition adds additional pressure.
Despite a potential cut to the dividend, Amcor shares remain cheap. The fair value of $83 for narrow moat Amcor implies the shares are trading at a sizeable discount.
Esther notes that the market is overlooking the long-term upside by focusing on niche products and the benefits from a larger business with Berry’s range and scale. Amcor is expected to navigate the current economic conditions but its long-standing dividend growth strategy remains an open question.
