Avery Dennison (AVY) Q3 2023: Intelligent Labels Non-Apparel Up 75% as Destocking Nears End

October 25, 2023 | By EarningsIQ Research

Intelligent Labels adoption in logistics and food surged 75% in Q3, offsetting muted apparel and slow consumption. Sequential volume and margin improvement signals destocking is largely complete in Europe and nearing an end in North America. Guidance reflects cautious optimism, with management reiterating a $10+ EPS run-rate target but acknowledging macro uncertainty and variable recovery timing.

Summary

• Intelligent Labels Expansion: Non-apparel categories, especially logistics and food, are fueling platform growth and market leadership.
• Destocking Cycle Winding Down: Volume recovery is visible as inventory normalization progresses across key geographies.
• Margin Levers in Play: Structural cost actions and disciplined capital allocation are supporting earnings resilience amid soft demand.

Business Overview

Avery Dennison is a global leader in materials science and manufacturing, specializing in labeling, packaging materials, and RFID-based intelligent labels. The business operates two primary segments: Materials Group, which produces pressure-sensitive materials and graphics for labeling and packaging, and Solutions Group, which focuses on apparel branding, RFID, and external embellishments. Revenue is generated through product sales to consumer goods, apparel, logistics, and food companies, with a strategic focus on high-value categories and digital-physical integration.

Performance Analysis

The third quarter saw earnings in line with expectations, driven by sequential improvements in both volume and margin across core segments. Materials Group volumes improved as inventory destocking moderated, especially in Europe, and emerging markets like Asia showed solid growth. Solutions Group sales rose mid-single digits, but margin gains were tempered by higher employee costs and ongoing investments in intelligent labels.

Intelligent Labels delivered standout growth in non-apparel categories, up 75% year-over-year, though overall platform growth was constrained by continued softness in apparel. Free cash flow was robust, aided by disciplined working capital management and reduced capital expenditures. The company executed on cost reduction initiatives, including restructuring in Materials Europe, and continued to return capital to shareholders through buybacks and dividends.

• Volume Recovery Trajectory: Sequential improvement in North America and Europe, with Asia leading in growth, signals the end of the destocking cycle.
• Margin Expansion: Productivity actions and raw material cost deflation supported adjusted EBITDA margin gains, despite lower organic sales.
• Capital Allocation Discipline: Strong free cash flow enabled continued investments in growth platforms and shareholder returns.

Overall, the business is demonstrating resilience through cost controls and strategic investment, but broad-based demand recovery remains gradual, especially in consumer-exposed segments like apparel.

Executive Commentary

Strategic Positioning

1. Intelligent Labels Platform Diversification

The company is aggressively advancing its Intelligent Labels platform beyond apparel, targeting logistics and food as new high-growth verticals. These categories offer significantly larger addressable markets, with food alone cited at 200 billion units. Early adoption in logistics and food is providing tangible customer value and creating proof points for broader industry uptake.

2. Portfolio Shift to High-Value Categories

Avery Dennison is deliberately reallocating capital and R&D toward high-value, higher-growth segments, both organically and through M&A. The recent acquisition of Silver Crystal Group in sports apparel customization exemplifies this push, aiming to build long-term growth platforms beyond legacy materials businesses.

3. Cost Discipline and Structural Productivity

Temporary and structural cost reduction actions, including European footprint optimization, are supporting margin resilience amid demand softness. Raw material cost deflation is being passed through to customers, maintaining competitive pricing and customer loyalty while protecting profitability.

4. Geographic Recovery Sequencing

Emerging markets, especially Asia, are leading volume recovery, while Europe’s destocking appears complete and North America is expected to follow by year-end. This geographic sequencing informs management’s cautious optimism for sequential improvement in Q4 and beyond.

5. Capital Allocation and Shareholder Returns

Management is balancing investment in growth platforms with shareholder returns, as evidenced by $309 million in buybacks and dividends year-to-date, and $204 million deployed for M&A. The company’s net debt to EBITDA ratio remains conservative, supporting flexibility for future opportunities.

Key Considerations

This quarter’s results highlight the interplay between cyclical volume recovery, structural cost actions, and strategic investment in digital-physical integration. Investors should weigh the following:

• Intelligent Labels Non-Apparel Momentum: Sustained 75% growth in logistics and food is expanding the platform’s total addressable market and validating the long-term 20%+ CAGR target.
• Apparel Weakness Offsets Platform Growth: Apparel demand remains subdued due to cautious retailer sentiment and slow consumption, limiting overall platform growth to low double digits.
• Destocking Cycle Nears End: Sequential volume improvement in North America and Europe sets the stage for organic sales recovery into 2024.
• Cost Actions Cushion Soft Demand: Structural and temporary productivity measures are protecting margins and supporting cash flow during the recovery lag.
• Capital Allocation Remains Flexible: Management is prepared to adjust debt paydown and M&A pacing depending on market opportunities and recovery speed.

Risks

Macro uncertainty and muted consumer demand, especially in Europe and apparel, present ongoing risks to volume recovery and margin expansion. Management’s $10+ EPS run-rate target is contingent on normalization of volumes, which remains difficult to precisely time given volatile end-market conditions. Currency headwinds, competitive intensity in RFID and digital solutions, and the execution risk of large-scale rollouts also warrant close investor scrutiny.

Forward Outlook

For Q4 2023, Avery Dennison guided to:

• Adjusted EPS of $2.10 to $2.25, up significantly YoY and improving sequentially at the midpoint.
• Organic sales growth driven by volume recovery in label materials and accelerating intelligent labels in logistics and food.

For full-year 2023, management maintained guidance:

• Incremental pre-tax restructuring savings of ~$65 million.
• Capital investments of ~$300 million, reduced from prior outlook.
• Full-year adjusted tax rate in the mid-20% range.

Management highlighted several factors that will drive sequential improvement:

• Normalization of label materials volume as destocking completes.
• Continued expansion of intelligent labels, especially in non-apparel categories.
• Ongoing structural cost reductions and productivity actions.
• Cautious consumer and retailer sentiment factored into guidance, with recognition of potential for more measured recovery.

Takeaways

Avery Dennison’s Q3 underscores a pivotal transition from destocking-driven contraction toward sequential recovery, with intelligent labels providing a clear growth vector outside of apparel.

• Non-Apparel Intelligent Labels Surge: Logistics and food adoption validates management’s platform thesis and expands long-term growth visibility, even as apparel remains a drag.
• Volume Recovery and Margin Discipline: Cost actions and productivity gains are cushioning the slow macro recovery, with sequential improvement evident in both core segments.
• 2024 Watchpoint: Investors should monitor the pace of apparel rebound, the sustainability of non-apparel growth, and the company’s ability to maintain cost discipline while scaling new platforms.

Conclusion

Avery Dennison is navigating a challenging macro environment with disciplined execution and strategic investment in high-value growth platforms. The company’s ability to drive sequential recovery and expand intelligent labels adoption positions it well for long-term value creation, though the timing of full normalization remains uncertain.

Industry Read-Through

The accelerating adoption of RFID and intelligent labels in logistics and food signals a structural shift in supply chain digitization and traceability, with implications for packaging, logistics, and retail technology vendors. Materials and packaging peers should expect continued margin pressure from raw material price pass-throughs, while apparel and consumer goods suppliers may face a protracted recovery as end-market demand remains tepid. The measured pace of destocking normalization seen at Avery Dennison is likely mirrored across the broader industrial and consumer supply chain ecosystem, suggesting that inventory-driven headwinds are abating but not yet fully behind the sector.

AVY Materials Packaging RFID Intelligent Labels Supply Chain Capital Allocation Restructuring