FO Fortune Brands

Avery Dennison Corporation (AVY) reported net income of $49.8 million or 47 cents per share in the third quarter of fiscal 2011, down considerably from $64.2 million or 60 cents per share delivered in the year-ago quarter.

The company incurred restructuring costs of $1.7 million or 1 cent and $1.8 million or 2 cents in the reported quarter and the year-ago quarter, respectively. Excluding these charges, Avery Dennison’s adjusted income in the quarter stood at $51.5 million or 48 cents per share versus $66.0 million or 62 cents per share in the year-ago quarter. Adjusted earnings per share were well below the Zacks Consensus Estimate of 59 cents per share.

Total revenue in the third quarter increased to $1.70 billion from $1.64 billion in the prior-year quarter, marginally exceeding the Zacks Consensus Estimate of $1.68 billion. The increase in sales was attributed to improvements in two of its segments, namely Pressure-sensitive Materials and Other specialty converting businesses. The other two reporting segments, Retail Branding and Information Solutions and Offce and Consumer Products registered declines in revenues.

Cost of sales during the reported quarter increased to $1.26 billion from $1.18 billion in the year-earlier quarter. As a result, gross profit declined to $435.7 million from $453.0 million in the prior-year quarter.

Marketing, general & administrative expenses were $326.4 million versus $346.4 million in the year-ago quarter. However, operating income declined to $70.9 million from $77.0 million in the year-earlier quarter.

Segmental Performance

Total revenue in the Pressure-sensitive Materials segment increased 8.9% on a year-over-year basis to $976.4 million. Label and Packaging Materials saw growth in revenues while revenues in Graphics and Reflective Solutions remained flat on a year-over-year basis. Consequently, operating profit also increased to $80.8 million from $72.2 million in the year-earlier quarter.

Total revenue from Retail Branding and Information Solutions declined to $360.5 million from $378.7 million in the year-earlier quarter. Decline in sales was due to lower demand from retailers and brands in the U.S. and Europe. Segmental operating income also decreased to $3.5 million from $11.4 million in the prior-year quarter.

The Office and Consumer Products segment revenues dipped 4.4% to $219.7 million in the quarter. The decline in sales was due to weak end-market demand. Operating income, however, increased marginally to $20.8 million from $20.4 million in the year-ago quarter.

Other specialty converting businessessegment reported net sales of $143.0 million, up 5.4% from $135.7 million in the year-ago quarter. The improvement was attributed to productivity-enhancing initiatives. The segment posted an operating loss of $0.1 million versus an operating income of $2.5 million in the prior-year quarter.

Financial Position

As of October 01, 2011, cash and cash equivalents of the company plunged to $119.7 million from $157.8 million as of October 02, 2010. Long-term debt also decreased to $954.5 million as of October 01, 2011 from $1.07 billion as of October 02, 2010. Similarly, inventories decreased to $571.2 million at the end of the third quarter of 2011 from $576.2 million at the end of the comparable quarter of 2010.

Cash flow from operating activities was $120.0 million in the first nine months of 2011 compared with $283.6 million in the comparable period of 2010. On the other hand, capital expenditure increased to $76.1 million in the first three quarters of 2011 from $50.1 million in the first three quarters of 2010, based on the company’s business expansion plans.

Consequently, the company generated free cash flow of $23.8 million in the first nine months of 2011 compared with $216.6 million in the first nine months of 2010.

Outlook

For fiscal 2011, management provided adjusted EPS guidance in the range of $2.15 to $2.30 and free cash flow guidance between $215.0 million and $235.0 million.

Our Take

The company remains committed to research and development as well as the discovery of new markets for its products. We believe Avery is well positioned in the upcoming quarters based on its dominant market share in emerging economies coupled with a solid cash position and lower debt levels.

However, weak results at Retail Branding and Information Solutions and Office and Consumer Products segments combined with raw material inflation remain concerns. Moreover, the company’s diminishing cash balance may restrict its near-term  potential investments.

Pasadena, California-based Avery Dennison produces pressure-sensitive materials, office products and a variety of tickets, tags, labels and other converted products. Avery is a Fortune 500 company operating over 200 manufacturing and distribution facilities with roughly 32,000 employees in more than 60 countries. It primarily competes with Bemis Company Inc. (BMS) and Fortune Brands Inc. (FO). The shares of Avery Dennison are currently maintaining a Zacks #5 Rank (Strong Sell rating) over the short term.

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