Amcor Plc (AMCR) — Q2 2022 Earnings Call Transcript

Thank you, operator, and welcome, everyone, to Amcor's first half earnings call for fiscal 2022. Joining the call today is Ron Delia, Chief Executive Officer, and Michael Casamento, Chief Financial Officer. At this time, I'll direct you to our website, amcor.com, under the Investors section, where you'll find our press release and presentation, which will be discussed on the call today. We'll also discuss non-GAAP financial measures and related reconciliations found in the press release and presentation on our website. Also a reminder that the call today includes some forward-looking statements, which remain subject to certain risks and uncertainties. Please refer to Amcor's SEC filings, including our statement on Form 10-K and 10-Q, to review factors that could cause actual results to differ from what we are discussing today. During the question-and-answer session, we request the participants to limit their questions to a maximum of two and then rejoin the queue for any follow-up. With that, I'll turn it over to Ron.

Thanks, Tracey, and thanks, everyone, for joining Michael and myself today to discuss Amcor's fiscal 2022 first half results. We'll begin with some prepared remarks before opening the floor for questions. I'll start with safety, which is where we start every meeting at Amcor. It's the first and most important of our values, and keeping every one of our 46,000 employees around the world safe and healthy is our highest priority. In the last six months, we reduced the number of injuries across the company by 10% compared to the prior year, and 58% of our sites have remained injury-free for at least 12 months. Our teams have continued to make good progress on safety despite the complex environment, and we're proud of their focus, dedication, and performance. However, our ultimate goal is no injuries, so there is more for us to do. We have four key messages to set out today on Slide 4 for those following along with the webcast. First, we delivered a solid result through the first half, and we can confidently reaffirm our full-year guidance. While we continue to navigate through the challenging and dynamic operating conditions affecting the entire industry, our teams are executing and performing exceptionally well. We continue to prioritize our customers, and our scale and operational agility have enabled us to service demand and drive growth in priority segments while also recovering higher input costs at the same time. We've also increased cash returns to shareholders, which is our second key message. We now expect to return more than $1.3 billion of cash in fiscal 2022 through dividends and share repurchases. Third, we've built a strong foundation over the last several years, and we're focused now on investing for long-term growth with an emphasis on priority segments and geographies and our innovation capabilities. Finally, for many years, we've made great progress against a broad range of sustainability goals, and we're raising our ambitions again with a commitment to achieve net zero greenhouse gas emissions by 2050. Turning to the financial highlights on Slide 5, we delivered double-digit net sales growth, which includes approximately $650 million of price increases. We remain incredibly proud of our teams and the tools and capabilities we've developed over many years, enabling us to continue recovering and increasing costs in an environment characterized by broader inflation that we've seen for some time. Excluding this pass-through impact, organic sales grew 2% on the back of higher volumes and favorable mix. Both segments in every geographic region contributed to organic sales growth, and volume growth accelerated in the second quarter in both our flexibles and rigid packaging businesses. The Flexibles segment had a particularly strong quarter, generating high single-digit earnings growth, and margins remain strong. In Rigid Packaging, our results for the half were in line with our expectations. The business continued to experience a particularly challenging environment in North America, which resulted in operating inefficiencies and higher costs, although we're encouraged by a number of favorable trends we've seen through the half, and earnings improved as we exited the second quarter. EPS increased 9% for the half. Our financial profile remains strong and cash returns to shareholders are significantly higher. We've repurchased almost $300 million of shares in the first half, and we expect to repurchase a total of $600 million through fiscal 2022, which is $200 million higher than we anticipated last quarter. Combined with dividends, this means we anticipate returning more than $1.3 billion of cash to shareholders for the fiscal '22 year. With that, I'll hand over to Michael for some further detail on the financial performance.

Thanks, Ron. Hi, everyone. Turning to Slide 6 and beginning with the flexibles, the business performed very well through the half year as our teams demonstrated impressive focus when it comes to recovering higher input costs and managing operating performance, whilst delivering growth in higher-value priority segments. Reported sales growth of 10% for the half includes recovery of approximately $480 million of higher raw material costs or 10% growth compared with last year. In the December quarter, recoveries reached almost $1.1 billion on an annualized basis. Consistent with the outcome in the first quarter and as expected, the overall price cost impact in the first half was unfavorable, but remains manageable, given the diversity of materials we buy, the multiple regions in which we consume those materials and the implementation of a broad range of pricing actions. As a result, margins have remained strong at 12.9%, despite higher raw material costs and related pricing recovery. At $480 million through the half, the top-line recovery alone had an unfavorable impact on margins of 130 basis points. Excluding this raw material impact, revenue growth of 2% was driven by favorable mix across the business, and reflects our long-term strategy of optimizing performance through the delivery of consistent growth in priority segments, including health care, coffee, and pet food. Notwithstanding the dampening effect on volumes that supply chain disruptions had during the period in some categories, including health care and protein products, overall volumes across the business were in line with the first half last year, and we saw low single-digit volume growth in the December quarter. In terms of earnings, adjusted EBIT was up 7% for the half and reflects growth in high-value segments and strong operating cost performance. Turning to the Rigid Packaging business on Slide 7, reported sales grew by 17% in the half, including 13% related to the pass-through of higher raw material costs. Excluding the raw material recovery, the business delivered year-to-date sales growth of 4% against a strong period of double-digit growth last year, and this included a 3% increase in volumes as well as a 1% price mix benefit. In North America, underlying demand in the beverage business remains strong, and year-to-date volumes were 3% ahead of the same period last year, accelerating to 6% in the December quarter and building on 13% growth delivered in the second quarter last year. Hot-fill container volumes were broadly in line with the second quarter last year, notwithstanding that we are cycling growth of almost 30% in the prior year. We have seen good volume growth in isotonics as well as iced tea categories, where customer demand for 100% recycled PET bottles has been strong. Specialty container volumes were lower against the prior year, which also benefited from higher volumes in the home and personal care category. In Latin America, the business delivered double-digit volume growth reflecting strength in Argentina, Mexico, and Colombia, and earnings were higher. From an earnings perspective, the business in North America was adversely impacted, as we expected, by inefficiencies and higher costs resulting from industry-wide supply chain complexity and disruptions. As Ron mentioned, earnings performance improved as we exited the second quarter, and this was helped by a number of positive trends, including better availability of PET resin and new capacity coming online, which also supported our ability to build some additional inventories ahead of the peak summer season. Although the operating environment is likely to remain dynamic and somewhat complex, we anticipate conditions will continually improve, and earnings for the Rigid Packaging segment are expected to grow in the second half compared with the same period last year. Moving to cash and the balance sheet on Slide 8, first, as a reminder, our cash flow is seasonally weaker in the first half of the fiscal year, and this year, we delivered cash flow within our range of expectations for the half, particularly in light of a higher cost environment. First half cash flow was below last year, and this mainly reflects the timing impact of higher raw material costs on working capital across the business, along with planned inventory increases. We continue to maintain a strong focus on working capital performance, which is even more critical in an inflationary environment, and our rolling working capital to sales ratio remains below 8% and in line with last year. As planned, capital expenditure is tracking higher than last year as we have stepped up organic investments in priority segments and geographies. Amcor's balance sheet remains strong with leverage at 2.9x on a trailing 12-month EBITDA basis, which is where we expect to be at this time of the year, given the seasonality of cash flows. Cash returns to shareholders in the first half were almost 50% higher than last year, and we increased our quarterly dividend per share and repurchased a greater amount of shares. We now expect to allocate a total of $600 million towards share repurchases in the 2022 fiscal year, which includes the additional $200 million announced today. Taking us to the outlook on Slide 9, the business has delivered a solid result for the half, in line with our expectations, and the outlook for our business remains positive. This enables us to do two things today. First, reaffirm the 2022 guidance we outlined in August and November, where we continue to expect adjusted EPS growth of 7% to 11% on a comparable constant currency basis, which represents an EPS guidance range of approximately $0.79 to $0.81 per share on a reported basis, assuming current exchange rates prevail for the balance of the year. We continue to expect free cash flow in a range of $1.1 billion to $1.2 billion. Secondly, our positive outlook leaves us well positioned to increase our share repurchase by $200 million in fiscal '22, as previously mentioned. It's important to note that the majority of these additional repurchases are expected to take place in the fourth quarter, and due to the limited impact this will have on the weighted average number of shares outstanding in fiscal 2022, there is not expected to be any real benefit to EPS growth until fiscal '23. So with that, I'll hand back to Ron.

Okay. Thanks, Michael. Before closing and turning it over to Q&A, just a few minutes on the longer term, starting with our investment case on Slide 10. We've maintained a consistent strategy for several years that has guided how we've evolved our portfolio and developed our capabilities. As a result, Amcor is better positioned strategically than ever before with a stronger foundation for growth and shareholder value creation. We've managed the portfolio so that we're now the global leader in most of our chosen segments within the primary packaging space for fast-moving consumer goods and health care products. We have absolute and relative scale advantages and a strong track record of performance, and that track record relates to our consistent earnings growth, margin expansion, and the significant free cash flow we generate every year. With a strong balance sheet, we're able to use that cash flow to step up investments for growth, including in fiscal '22, where we expect CapEx will be about 15% higher than last year, and we can see that leading to increasing momentum across the business. At the same time, we're also returning a significant amount of cash to shareholders in the form of regular share repurchases and a growing dividend. Now organic growth has always been a key driver of our overall financial performance, and we're actively investing in several areas highlighted on Slide 11 that will continue to drive long-term growth. First, we're strategically focused on the most attractive segments, and this guides how we prioritize investments back into the business. We'll talk more about these segments in a minute. Second, we continue to see tremendous opportunities to invest and extend our competitive advantages in emerging markets. We already have a leading emerging markets portfolio that generates roughly $3 billion in annual sales, and we see no shortage of growth opportunities in these markets, where we expect mid-single-digit growth and good profitability over the long term. Third, innovation in our world-class R&D capabilities remains a clear differentiator for Amcor. Innovation will increasingly contribute to organic growth going forward as we partner with customers to develop more sustainable and high-performance solutions for their specific needs and those of their consumers. Slide 12 takes a closer look at some of those higher growth priority segments. These attractive segments are expected to represent an increasing percentage of our sales mix and contribute to consistent margin expansion. Amcor has a leading position in each of these categories, which collectively generate over $4 billion in annual sales today. These share a few common features. First, these are large addressable markets, each well over $1 billion, and the growth rates are all higher than the average across broader consumer markets, meaning there's significant room to grow. There are also many opportunities to differentiate across these categories, given the need for higher performance features such as barrier, heat resistance, and resealability, which in turn drives higher margins. To fully capitalize on this great potential, we're increasingly allocating capital towards these segments. In health care, we're investing to add capacity and capability in Europe and Asia. In this quarter, we celebrated the opening of a state-of-the-art medical packaging facility in Singapore to service accelerating demand in the Asia-Pacific region. Recently, we began ramping up production on new assets in the coffee segment, and we're adding hot-fill capacity in our rigid packaging business in North America, given the sold-out environment and positive growth outlook. Over time, we expect mid-single-digit growth in these segments, which will drive continued sales mix improvement and sustainable margin expansion. Moving to Slide 13, sustainability is becoming increasingly embedded in everything we do, and we continue to believe this represents our greatest opportunity for growth and differentiation. We also continue to believe responsible packaging is the answer to addressing concerns around packaging waste. By responsible packaging, we mean the combination of packaging design, waste management infrastructure, and consumer participation. Amcor recently commissioned a global survey that enabled us to hear directly from 12,000 consumers around the world and provided several powerful insights. Among them, recyclability is considered by far the most important environmental attribute of packaging, more important than which material is used or whether the package is reusable. Three-quarters of respondents indicated they would like to recycle more, and more than two-thirds said they're willing to pay more for a product for the package that's recyclable. Our package design efforts have always had the consumer front and center, and we're making great progress innovating against those consumer needs. Across our own portfolio, over 95% of our rigid and specialty container packaging is recyclable today. But our most significant progress over the last two years has been in our flexible packaging segment, where multiple materials are often required to deliver the required functionality. Today, 76% of our flexible packaging portfolio has a recycle-ready alternative, representing substantial progress from 56% just two years ago. An important contributor to this progress has been the launch and commercialization of new product platforms such as AmLite, AmPrima, and AmSky. Last week, we announced AmFiber, a new platform of performance paper packaging. These technology platforms will be leveraged across our global footprint, across multiple categories and for multiple customers to provide the more sustainable and high-performing packaging consumers are looking for and to drive growth and margin expansion for Amcor. Responsible packaging is a critical element of our sustainability agenda, but every company's environmental footprint goes beyond the products it makes. To lead the way and reach our ambitious goals, we launched Amcor's EnviroAction program in 2008, and since then, we've reduced the environmental impact of our operations by continuously exploring new and more impactful ways to reduce emissions, waste, and water at every location. The value created for our customers and the environment through our work on a range of ESG initiatives has been recognized by several independent organizations, and Amcor is continuing to demonstrate industry leadership. Last week, we increased our ambitions again by committing to achieve net zero greenhouse gas emissions by 2050, with near and long-term targets aligned with the science-based targets initiative. We're excited to step up our ambitions to further reduce the carbon footprint of our products and operations and to support our customers as they strive to meet their own goals for functional high-performance packaging with the lowest possible environmental impact. Finally, on Slide 15, to summarize, Amcor delivered a solid result through the first half as we continue to perform well through challenging and dynamic operating conditions, and we've confidently reaffirmed our full-year guidance. We've also increased cash returns to shareholders and expect to return more than $1.3 billion in fiscal '22 through dividends and share repurchases. Looking over the longer term, we've built a strong foundation for growth and value creation over the last several years. We're investing to capture that growth and building on our sustainability progress as we use science-based targets to define our journey to net zero emissions. With that, operator, we'll open the line for questions.

Yes. So for my first question, just the comments that you had in your press release about volumes being lower in certain categories like cheese, coffee, and frozen food, and then up in health care. As you step back around, is that just a function of mean diversion relative to pre-COVID levels? Could you just talk about what's actually going on in the end markets, in terms of other demand as the consumers in different regions such as the U.S. and Europe navigate extremely high inflation relative to the previous baseline in terms of purchasing patterns?

Yes. Ghansham, first, thanks for the question. I'm not sure it's mean diversion. I think we've sort of been back to more normal trading patterns now for at least five or six quarters. What we're seeing there is a good recovery in health care, which has been going on now for a couple of quarters in medical, and in the second quarter, we started to see better pharmaceutical volumes. We had high single-digit growth across the businesses in health care. That one is, I'd say, more of a return to normal trading conditions. As for the food categories, the only thing that I would point out that's exogenous is some supply shortages we have in key inputs. We're still leaving some money on the table with sales that we can't realize in an order book that we can't completely fulfill because we've got some materials that are just not as available as we'd like. That's the only thing I could point to. Otherwise, I think what you're seeing in the quarter and at the micro level at the segment level is just the ebbs and flows that happen over any 90-day period.

Got it. And then for my second question, there's obviously an enormous amount of beverage can capacity being added in North America, which will start to hit this year in particular. As you sort of look at your rigids business and backlogs, your share of new product introductions that beverage customers may be introducing, et cetera, how do you see that dynamic playing out for Amcor's rigid business?

Well, firstly, the demand in that business is super strong. That's actually the big driver of the profit shortfall that we've had so far in the first half, is that we're just oversold. In the second quarter, we had volume growth of 6%, which comes on a year-on-year comp that was quite strong a year ago. So the demand is really, really strong, would be the first point. We're adding capacity, as we've talked about trying to alleviate some of the bottlenecks. I think the second thing is that we've never seen the plastic container really in direct competition with the metal can because we see different distribution channels. You see PET primarily through the cold chain and through convenience stores and more single-serve, and you see the can historically through big-box retail and 12 and 24 packs. We've not really seen competition in things like iced teas or sports drinks, or our hot-filled juices. When we talk to our customers, and we're as busy as ever on new product introductions, they're not really talking about a trade-off between one format or the other. It's more about the format that's best aligned to their segment needs and goals. Cans have been growing quite rapidly, the capacity has been added for several years now. It hasn't slowed our volume growth really at all.

Ron, on rigids, given the supply chain issues and some availability issues that you've seen, would you anticipate getting back to sort of a normal level of profitability? Is that by the end of fiscal Q3 or the end of the fiscal year? I'm trying to understand what your full-year guidance assumes on that front. And as you look back on the first half, understanding maybe you can't do this, but in terms of the total EBIT impact of these disruptions, is there any way to kind of put a finer point around that on the rigid side?

Yes. Look, good question. First, the outlook for the business has been improving. Profitability has been increasing through the first half, and it continues to improve as we go into the third quarter. What we've said today is that we expect profit growth in the second half versus the second half last year. The pace of that will depend on several factors; thus, we're not calling out specific guidance for the third quarter. I expect as we get toward the back end of this fiscal year, which is around the May, June period, where the new high season is, I would like to think that we're going to exit this year at a more normal level of profitability. The reason I say that is there are several things that are working in our favor. Firstly, demand remains strong, and it always starts with that. To Ghansham's question, demand has remained very robust, particularly in the beverage space. That's the first thing. Secondly, we've been increasing capacity and adding incremental capacity throughout the last couple of quarters, almost on a monthly basis. We're going to add around 5% to 10% capacity in the hot-fill network. Thirdly, we're entering the third quarter with inventory and a reasonable amount of inventory, which is where you would typically expect to be at the start of the third quarter. It's a seasonal business, and entering January, February with inventory is crucial. Last year, we didn't have any, leading to a ripple effect that we are still working our way out of. Those are the reasons why we feel optimistic about the second half. The pace will be determined by how quickly we can bring capacity on stream and our availability of inputs. As for the second question about drivers of profit impact, it's hard to parse them out. There are three things going on: one is demand really outstripping supply at a rapid pace, leading to inefficiencies in a sold-out environment. The second is inflation, and we're recovering. You can see the price impacts on the sales line. The third is the performance of the business. As managers, we're trying to isolate how much is the performance of the business. We think it's been quite good, but it's hard to quantify the impact of those three different drivers.

Okay. That's very helpful. Then just switching gears on the AmFiber platform. Can you give any more details there in terms of any incremental CapEx investment, maybe percentage of your volumes that might be fiber-based either now or in the future? Is this targeting existing customers that are asking for a paper option, or is it going to cannibalize existing sales? Are you going after totally new customers, new categories? Just any details there.

Yes. It's rejuvenating categories that historically have not been at the highest level of priority for us. So confectionery is an important category for us in volume terms. This is a differentiated product that we're going to start launching in that particular segment, which changes our outlook on the attractiveness of that space and its profitability. Firstly, what is it? It's a paper-based platform that really threads the needle between the issues that pure paper solutions have—that there's no barrier—and coated paper, which tends to have much lower fiber recovery and therefore is not recyclable at times. The AmFiber platform kind of threads the needle between those two extremes. It has barrier properties, and the product runs on the customer filling lines at generally the same speeds, so there's no productivity discount the customer has to wear. We're really excited about it, and we're going to roll it out globally. I wouldn't expect any material change in CapEx specifically related to this platform. Still, we are investing behind these platforms generally and into growth segments, and we'll continue to deploy capital against the growth opportunity.

I just wanted to get a better understanding of the working capital build. I know you mentioned that some of that relates to price increases across the raw materials. Just wondered how much of it is anticipatory as well to avoid some of the supply chain issues you mentioned that the company was facing in the second quarter?

Yes. Jakob, thanks for the call. It's Michael here. Yes, look, as we outlined in the release, we've seen an outflow of working capital higher than the prior year. The key driver of that is raw material, both the raw material inflation and the timing of that flowing through the business. Additionally, in the second quarter, we were able to take some planned inventory increases, both in the rigid and flexibles business, and Ron alluded to that in the rigid space, where last year we weren't able to increase inventory at all. However, this year on rigids, we are entering the third quarter and have been able to increase inventory, which you'll see flush through the system in the second half. On the flexible side, we've seen some increases on a cautionary basis to ensure we've got supply. That's why we're confident around the cash flow projection for the business in H2 and for the full year.

The second part, maybe one for Ron. At the first quarter, you mentioned that you expected the resin supply as it relates to the rigids business to improve into the second half. Is that still the case? Is there anything that you're seeing on the horizon that would bring that resin availability into question?

No, not anything that threatens supply. I would say, we did see a modest improvement through the quarter. That's one of the reasons for a more positive outlook in the second half is that resin is generally more available. We're not all the way back to 100% supply, but we are in a much better position than we were three months ago.

I'd like to ask a question or two on sustainability. Ron, it looks like you're very well through your major sustainability goal of 100% recyclability by 2025 with only flexibles now at 75% coverage. Are you trying to start looking towards the next milestone? I see you put the greenhouse gas emission target out. I think most of your emissions are Stage 3. The question becomes, would you invest collaboratively with your supply partners to reduce greenhouse emissions? Are there opportunities for doing that? The other area I wanted to ask about was not only GHG, but waste management. How do you articulate and establish goals like you've done for recyclability for waste management infrastructure, which is one of your objectives?

Yes. Let me take the questions in order, Larry. So firstly, on the greenhouse gas emissions, this is the next logical step in our evolution and our journey. We've been on the greenhouse gas reduction path for over 15 years now. Back in 2008, we set our first public targets to reduce greenhouse gas intensity by 60%, and we're well on our way to doing that. That was a 2030 goal. Every few years, we set a new benchmark for each of the areas of our EnviroAction program: greenhouse gases, waste and water. We're at a moment in time where it's time to rethink our objectives and speak in the same language as others. The science-based targets initiative has helped bring standardization to how companies talk about their greenhouse gas profile, and we're jumping on board with that initiative. We'll set some near-term targets over the next 24 months as we work with that group to validate and qualify our targets. We'll report out on what those targets are on the pathway to net zero by 2050. As far as the waste management part of the equation, you're right; we're making fantastic progress on the packaging design aspect of responsible packaging. We're going to reach 100% of the portfolio with a recycle-ready option by 2025, and we have no doubts about that. The take-up and demand from customers have never been stronger. Many of them have the same goals. Waste management, it's also something we can influence, but not alone. That’s where alliances and work with the Alliance to End Plastic Waste, the Consumer Goods Forum, and other initiatives come into play. Ultimately, we all have a role to play, including government, Amcor, our suppliers, and customers to make that happen, but it cannot be Amcor alone.

That's why I focused on those two areas because unlike recyclability, these two things are out of your control and may require significant capital investments more than the recyclability objective. Should you be paying dividends and buying back shares to the level you are if the next sustainability objectives are going to be capital intensive and require partnerships that align with plastic waste? They talked about $1.5 billion of capital commitments by 2024. In their 2019 accounts, they did $8 million of subsidies. Maybe there's an invoice coming for some $200 million of infrastructure capital that's going to hit your desk, I don't know. It sounds like you may need to put a stake in the ground in terms of the investment levels to reach those other objectives.

Look, I'm not anticipating that we're going to put real meaningful capital into that part of the value chain. We are investing in pilots, and we're happy to help fund pilots that are proof of concepts, and we're also happy to supply demand in the form of off-take agreements. We have lots of pilots underway with several of our suppliers on chemically recycled materials, etc. But waste management is not a narrow exercise. It’s a local activity, collecting various materials, some of which are packaging after use but only a portion. It will take a lot of money to get waste management infrastructure around the world where it needs to be. I'm just not sure that as a converter, it's the best use of our shareholders' capital.

Just quickly, acquisitions; we haven't seen much from Amcor since Bemis. I'm just wondering what you're seeing in terms of deals, are they businesses that don't align, or are the prices too high?

It's a good question. We would like to be active. The industry has been acquisitive with a reasonably good track record of generating value from acquisitions, and we'd like to continue to do that. We're constantly in the deal flow. If there is a deal in our space that you're reading about, you can rest assured that we've looked at it. There are a couple of things going on here. It's only probably the last nine months or so we've embedded down Bemis. That was the largest acquisition the Company had ever done by a factor of three, and we were laser-focused on making that a success for the first 2, 2.5 years, which brings us to the last couple of quarters. I think that's well behind us now, and we certainly have the capacity to take something else on. At the same time, we have asset prices that are elevated, and businesses are particularly tough to diligence right now. Increasingly, this will dissipate. The complexity relates to top-line impacts COVID has had on different businesses, making assessments difficult. It’s a challenging period, and we’ll remain disciplined, but we’ll be active and get back on the acquisition bandwagon sometime soon.

I wondered for the first question if you could confirm where we're at in terms of recovery in the medical device packaging area. I know Bemis has put a lot of money into a new facility up at Oshkosh. With the drop-off in elective surgeries, that business was running short of capacity. Can you just update us?

Yes. Medical device packaging is as good a segment as we're participating in. We’ve seen steady improvement over the first half of this fiscal year. I'd say that demand is not all the way back, but most of the way there. Demand is driven by elective procedures, surgeries, and the like. Demand has mostly recovered from its lows during the COVID period. There are also some resins we use in that business, which ensure supply. That's also held us back a little bit. We are probably 2/3 to 3/4 of the way back to the baseline you'd expect in that business. This is a high-profit segment with a lot of differentiation and innovation, and historically, it has grown at mid-single-digit rates. In the first half, we've actually seen that, but we also realize there's more to be had there.

Got it. And then the second question I had is another follow-on around M&A. A long-time entrepreneur in the premium carton market has a new private equity vehicle. In my mind, there is a question about how you would assess the options around your carton business. How would you have us think about how you assess that business?

The cartons business sits between 7% and 8% of our sales today, but it's an important piece of our offering. Even the AmFiber platform speaks to the importance we place on having a diversified substrate mix. It's a highly cash-generative business with a clear leadership position in its market, and it’s an important part of the portfolio. That said, we're rational economically, but there's no desire to shift the portfolio at this point.

I guess, first of all, I'm not surprised by what you found from your study, Ron, in terms of recyclability being most important for the customer, for the consumer, and really translating that into recycling will be key from here. I guess I had an operating question and then kind of a follow-on bigger picture question. So in rigids, you had these operating issues and inefficiencies through no fault of your own, which have taken away performance from where it otherwise would have been. What options do you have as contracts come up for renewal? Do you have a desire to build in additional clauses to capture some of those inefficiencies when they're beyond your control and you're doing what you can to service a customer? Relatedly, in the flexibles, with the volume accelerating in the quarter versus Q1, and certainly all the pricing action you're seeing, I would have expected maybe a bit more dollar traction in EBIT in the quarter. If there's a way to quantify if inefficiencies in flexible impacted performance in Q2, recognizing you're happy with the performance, it would be great.

I'll take the rigids question, and Michael can comment on flexibles and the raw materials impact there. The contracts are quite robust. Ultimately, we always have to make a choice at the level of demand that we've seen in that business. You run into this periodically; you're sold out, and when you're sold out then the cost to produce the marginal unit becomes almost infinite. Even though we say our contracts have served us well and been fair with customers, you get into situations where you'd probably make more money if you didn't take the last order. While we're in this for the long haul, we have customer relationships that date back decades. You sort of have to wear it a little. Customers are also experiencing their disruptions trying to service their peak demand. I'm not sure there’s a contract mechanism to capture the uniqueness of the environment we faced. I think the answer is to get out in front in terms of inventory build when you have a seasonal business like ours and ensure we're keeping abreast of the capacity needs and adding capacity regularly, which is what we're doing. Maybe Michael can comment on the flexibles profit impact and leverage.

Yes, sure. On the flexible space, we closed the half out, EBIT grew 7%, pretty consistent growth over both quarters. We’re still cycling some high raw material costs. We recovered $480 million in the top line—that’s about 10%. That said, there was still some price-cost lag, which is manageable but it did have an impact. As we look forward, we expect that to start easing in the second half. Overall, we feel good about the flexibles business. Margins have held strong at 12.9%. If you take the raw material impact out, margins would have been 130 basis points higher and indeed 70 basis points ahead of the prior year. We feel positive about the flexible performance.

I appreciate the thoughts. A quick one just in terms of the increasing of the value return. I don't think anyone's complaining, but considering that you only maintained your guidance, and again, you're having a solid year, in line with expectations, what prompted your ability to raise the value return recognizing it will happen at the end of the year?

No, look, underlying performance of the business is strong and enabled us to announce that further buyback. We have a strong balance sheet right now, the cash flows are solid, and the second half looks strong. We announced $400 million back in August; we've announced a further $200 million, both have solid underlying performance enabling us to do that.

Ron, just a quick question, well not a quick question, but it's a question I've asked before over the last couple of years, just around Bemis. I know the focus has been on the integration of that business and delivering cost synergies. Now that the heavy lifting is being done, is your focus now able to shift to start realizing some of the potential revenue synergies from that acquisition? What extent is that related to the growth targeting in these priority flexible segments?

Yes. The short answer is yes. I believe we've been extracting commercial benefits from day one through different ways of managing mix and managing raw material pass-through. The capabilities Amcor brings have been accruing benefits over the legacy Bemis portfolio from the beginning. As far as growth, no question; the organization is orienting itself towards generating more growth. We have several tools at our disposal to do that. You see evidence already of things you could label revenue synergies. Looking at new product platforms we've spoken about, in some respects, those are examples of revenue synergies. The AmLite platform, which is a recyclable pouch for human food or pet food is an innovation Amcor developed, which will be leveraged over the legacy Bemis footprint. Conversely, the AmPrima platform, a recycle-ready, all-polyolefin structure is a legacy Bemis platform leveraged around the world on the legacy Amcor footprint. The agenda is evolving, and we're seeing benefits in real time here and probably have been for the last couple of years.

Got it. Final question, just on the volume growth of 1% across the group this half, notwithstanding the supply chain constraints and challenges, what sort of volume do you think was on the table because of those issues?

I would say another 1% or 2%. It's the delta between the long-term average of low single-digit growth, which is a couple of percentage points and where we were. This is a business that prioritizes mix, and sometimes you don't satisfy all orders. I'd say it's a couple of percentage points.

On M&A, you have integrated Bemis, which was a large transformational acquisition. Would you have the appetite and willingness to complete another large transformational deal in the near term and maybe increase your resin buying scale if such a deal were to come to market? Or would you be looking at bolt-on deals or specific technologies or end markets rather than just scale?

Yes, I would probably say that we wouldn’t be doing something just for scale. I'd love to be able to fund something like that, and the company has shown over the years its drive toward big transactions, such as Bemis and Alcan. These are company-defining transactions that lead to new levels. We'd love the opportunity to pursue something like that. The target set is what it is, and the competition means most deals—90-plus percent of the opportunities—will be characterized as bolt-ons. Strategy first, scale second; we wouldn’t do something just to get bigger. On Latin America, volumes are up nicely in that region. It seems like volumes are impacted by the macro economy in Brazil or rising COVID cases. Latin America has a tale of multiple stories for us. In the Rigid segment, we had a fantastic half with double-digit volume growth and strong earnings growth. In the flexible space, we're exposed to other categories—Home & Personal Care, for example—which had a strong year a year ago. So volumes are behind in the flexible space, making it mixed. In Food and Personal Care segments, we have seen more impacts from the macro environment and COVID impacts, whereas in the beverage space, we haven't faced those impacts. It’s a bit mixed, but we’re confident in the long-term outlook.

Just the first one on the flexible side. I appreciate it's only a 90-day period. But there was a slightly less incremental earnings uptick in the second quarter versus the sequential first quarter than what we've seen historically. There looked to be a bit of adverse effects in there. Was there a slightly larger earnings drag from raw materials in the second quarter versus the first? Or anything else to call out there?

Overall, it was a consistent performance quarter on quarter. I mean it’s a 90-day period. There were some minor puts and takes. In terms of raw material price costs, that remained consistent overall as the lag is manageable. Nothing to call out on that front.

Just the second one. Interested in what you're observing on raw materials. You've commented on supply chain and rigids improving, but on raw materials, you're expecting relief in the second half. I think U.S. resin prices have come back a bit, but you've also announced up to a 15% price rise effective January.

On the raw material side, you're right; it's mixed across the globe as we exited the second quarter. We began to see some easing in North America and Latin America, but in Asia and Europe, you're still seeing increases. Overall, we see things reasonably stable and perhaps easing slightly in Q4, but we'll see.

I want to come back a bit about the fiber packaging that you're investing in. If you can talk a little about your view on plastics versus fiber. We’ve seen some vocal advocates that plastics can be better from a sustainability standpoint. You’re not seeing any significant substitution or at least not on a larger scale. How has your view changed? Are you seeing bigger threats to plastics in some regions?

No, we see a big opportunity to—and there’s a sweet spot in the fiber-based or paper-based flexible area where we think we have a good solution. So somewhere between pure paper solutions, which typically have less functionality, and coated paper, which traditionally has lower fiber recovery and is not recyclable at times. The AmFiber platform effectively threads the needle between those two extremes, providing a paper-based solution for those who want one. There are certain categories where paper solutions exist, like confectionery; we’ve had some paper offerings in that segment for a long time. This is more about a product-based opportunity than anything else. In our view, plastic-based flexible packaging quite often is the best environmental solution to satisfy all the different criteria our customers and consumers have. There's no philosophical change; it's simply an opportunity to deliver innovation we think is unique.

Great. So essentially, it's more of an offensive move rather than defensive here?

Yes.

Can you remind us what your paper converting opportunities are, excluding folding cartons, which is a different category? What businesses do you have, in which regions, and how significant would M&A be to expand your innovations in fiber packaging?

In the Flexibles perimeter, excluding cartons, we have a big oil-based business and a reasonable business with paper in the structure. Both are global. We have paper-based structures in medical packaging, and we have paper solutions in protein. We have a platform called SkinNova, which is a laminate that peels off and a paper-based tray for meat. We have another called Paperly. We've always had paper solutions; it’s probably not the largest part of our portfolio, but collectively, paper and foil would be around 20% of our flexibles portfolio. On M&A, I'm not sure that’s the right strategy to expand here. Growth in this space will largely come from innovations, and we think we've got the capability. There are good ideas that we can access in a commercial sense, but we don't foresee any significant material M&A against this trend.

A lot of ground has been covered this evening. I’ll focus on just one question on the demand side. Earlier you spoke about what you're hearing from your packaged food and CPG customers around demand elasticity, given all the inflation they're absorbing and passing on to consumers. Are you seeing any signs that the consumer can't take anymore in terms of price increases? Are you seeing that impact specific categories or shifts into value or things that would impact your volumes and mix as you look out over the course of calendar '22?

It's a good question. I think it's on everyone’s mind. First, I'd contextualize it by reminding you that in almost every category we're participating in, packaging is a very small part of the overall cost of goods that our brand owner customers or health care customers are bringing to market. It's not the most material driver of their income statements. That said, from the conversations with customers and their public commentary through this earnings season—likely even the last one—they're not seeing the elasticity they may have historically modeled. At this time, price increases seem to be going through across the categories that we’re exposed to.

Ron, just a follow-up on John's question around price-cost and completing that discussion point. Price-cost was upside down in the quarter, and raw materials have flattened off. You’ve got price increases in the mix now. Do you expect price-cost to come out neutral in Q3 and potentially right-side up in Q4? Can you give us clarity on that?

Yes. Keith, it's Michael here. As we said, the first half saw the price-cost lag that was unfavorable but manageable. As we see raw materials begin to stabilize heading into Q3, we expect that the price-cost lag should ease as we progress into Q3 and potentially get closer to neutral. Looking into Q4, if raw materials do ease, as industry forecasts suggest, there could be slight positive recovery in the fourth quarter, but let’s wait and see.

Just to be clear, you're not expecting the price-cost issue to worsen as the year progresses?

Correct.

Excellent. On cash flow, we've talked about working capital unwinding. But could you target a quantum of cash flow into the second half of the year? I think in the last couple of years, it's been around 75% of target needed to deliver in the second half. Is it purely the factors you called out—working capital unwind and slight improvement on capacity to generate more cash flows?

Yes. Cash flow is seasonally weighted to the second half and particularly Q4. In the first half compared to last year, we saw unfavorable impacts in working capital and inventory. We're expecting a better second half, with higher earnings as key elements driving this outcome. Cash flow seems consistent with the previous years if you examine the second half last year, considering the adverse impacts we experienced in the first half should unwind. Thus, we feel pretty confident around that.

I'd just like to highlight on Slide 10. Could you give us an update around your targets or using recycled material in your packaging, please? Just where you're up to on that?

Yes. We have a target to use 10% recycled content by 2025. We're making great progress, predominantly in our Rigid Packaging business. We've gone from 5% in 2019 to over 10% last year. This year, we'll be well over 15%. In terms of actual tons, that number is doubling roughly every 18 months, so significant progress. We're also excited about applications in flexibles and the projects we're doing around chemical recycling to further enhance that number.

Are you seeing any difference in the pricing of recycled materials?

Absolutely. The pricing for recycled PET is currently 40% to 50% premium over virgin materials. That number ebbs and flows, but it's primarily demand-driven right now.

Ron, just a couple of quick questions on rigid plastics. To what extent do you think the business is in a strategic disadvantage, and that may explain some of the profit impact we’re seeing? I mean, your principal competitors have a greater on-site presence than you do, so I was wondering if that's having an impact?

Thanks, Richard. No one in this space is having an easy time of it, as you can see from others' results. I don't think we're at a disadvantage. We have sizable on-site installations in the beverage side of the business which is where it matters most. We have scale from a network and procurement perspective. So I don't think the business is disadvantaged; it's just a combination of factors that have conspired to lead to a rough profit outcome for a couple of quarters.

So sort of following on from that, when you think about it strategically, given that pretty much everybody else in that space has moved to an on-site strategy, how do you think about the long-term prospects of that business given you've gone in the other direction?

I don't think we've gone in the other direction. Over time, much of the capital deployed in the Beverage segment of that business has indeed been for on-site installations, but that's not necessarily a solution for every scenario. There are times when it makes sense to go on-site and times we find it best for everyone—including the customer—to supply from a different location. It's not necessarily one size fits all. Our network has been more on-site than off-site in capital deployment, but I don’t think our footprint creates any disadvantages.

On Slide 13, can you provide an update around your portfolio on Flexibles that needs to be designed between now and 2025? Can you provide some of the large segments where roughly that portfolio is remaining to be redesigned? Also, what does profitability look like for the remaining 25% compared to the redesigned proportion?

The structures still to be redesigned are often the more sophisticated ones out there. You wouldn't be surprised to hear me say that. They're situations where we believe we have some competitive advantages. This will take some more time, as the science involved is more complex. There are segments in medical and health care, and some in protein structures where we’re still working on alternatives. The remaining portfolio is the more challenging, but also some of the more profitable segments.

Thanks, operator, and thank you to everyone for joining us today and for your interest in Amcor. We've had a solid first half, and our outlook is for a strong finish and a very strong fiscal 2022. With that, we'll close the call.