Investment case: Aluflexpack

Resilience / Recurring Revenues

When we look at a company’s activities, we always ask what will happen with it in a downturn. It is not that we shy away from a cyclical company, but we want to be sure that its products serve a need that must be filled. This need can arise as a result of 1) continuous use, think about your Office365 software from Microsoft; 2) replacement (parts) needed, such as ink in a printer; 3) wear and tear of essentials, such as flooring in hospitals; or 4) or must-have consumer goods such as food and medicine. Aluflexpack serves customers that are active in industries that have shown a history of resilience.

Come good times or bad, we will always need to eat and use medicine. These products require packaging. This makes AFP part of the value chain in what has now become known as ‘critical industries.’ These critical industries continue to operate in a worldwide crisis such as the COVID-19 pandemic.

What we also like about this business is that client retention is very high. AFP has essentially not lost customers involuntarily for years. It has focused on increasing business with large customers by working together on new products or win dual-sourcing contracts for existing products. Clients can be retained for decades, as is the case with for example Ferrero Rocher. It makes the foil for the bonbons. While this may appear to be a commodity type product, it isn’t. Each product requires packaging specific to the production process keeping the product fresh during transport, in store and at home. Reliability is king.

Switching suppliers for customized packaging is not a simple process. It requires red tape related to recertification of new suppliers. This process costs a lot of time and money in return for minimal benefit. The cost of the packaging in relation to the product is ordinarily very low.

Last but not least, in times of severe economic stress, the importance of a strong balance sheet cannot be underestimated. Aluflexpack has no debt on its balance sheet after deducting its cash balance. This results in the company being resilient should orders be cancelled and becomes loss-making. Not that we expect this to happen. Quite the opposite.

Management + Insider ownership

In order to ensure long-term and true alignment, we generally require management or a founding family to own shares in a company we invest in. In the case of Aluflexpack, we have Montana Tech Components which continues to be the majority shareholder. We got to know MTC when we first participated in the initial public offering of Varta AG in 2017. MTC is owned by a 53-year old German/Austrian billionaire, Mr. Michael Tojner. His story is more typically found in America, where rags to riches stories are almost a requirement to lead a tech firm. Mr. Tojner was the son of a plumber and a teacher. His taste for entrepreneurship and investing was sparked when he went to university in Vienna with little money. With strong determination to create a living for himself that could equal the wealthier students around him. Initially he opened ice cream shops, employing more than 20 students. He then opened a dance club. His big break came when he founded online betting site Bwin, an idea he came up with during a conversation with friends. Initial wealth generated from his previous ventures allowed him to invest Eur 3 million and collected 10 times the amount in returns, with which he founded Montana Tech Components (MTC).

MTC is a technology and innovation-driven industrial group. With his company, he acquired Varta in 2007 for Eur 30 million. He also acquired Aluflexpack in 2012. Other activities in the Group are related to aluminium profiles and ready-to-install components for the aerospace and other industries. Each of these businesses has seen substantial growth.

Since the stock market listing of Varta in 2017, the market cap has seen tremendous growth. Mr. Tojner still owns 58%. Aluflexpack is another company that under his ownership has grown significantly and is taking significant steps to grow for many years to come. What we value highly is that we, as external investors, can be assured that management acts as an owner-operator. They don’t waste shareholders’ money on capital expenditure that offers a low return. Nor do they engage in empire building by making ‘strategic acquisitions,’ otherwise known as overpaying for buying revenues.

If you would want us to summarize our strategy in one sentence it would be: we co-invest alongside successful entrepreneurs and stay with them for the long-term. We believe this is a great way to compound capital.

Entry Barriers

The number of companies active in packaging is large. That would imply barriers to entry are low. This is however not really the case. The sector has witnessed consolidation as clients increasingly prefer to do business with a packaging company that can offer all capabilities under one roof. This allows the client and the packaging manufacturer to work together effectively on innovative packaging.

While pricing is always a consideration, especially in negotiations with large customers, it is not the variable that helps Aluflexpack win new clients. AFP differentiates itself by being nimbler and more innovative. Aluflexpack has a ‘can-do’ mentality. Large competitors are said to be slower or less flexible in working together with clients. Sometimes they are owned by private equity, which often creates a culture focused on shorter-term financial results.

Market share is not a relevant criterion to look at, although scale is important. Being one of the larger players also allows AFP to attract large customers, such as Jacobs Douwe Egberts, Alpro, Ferrero Rocher and many more.

Growth Prospects

We believe that AFP has a long runway for growth in the decade ahead. One of the key growth drivers is its manufacturing capabilities in aluminium coffee capsules. Jacobs Douwe Egberts (JDE) is its key customer for capsules in Europe. These cups can be found in the supermarket, amongst others under the L’Or brand. Illy also uses AFP’s capsules, and more are to follow. What intrigues us is that Nestlé is single sourcing its capsules. This is highly unusual. It tried dual sourcing years ago but this failed miserably so they went back to their single source. We believe that AFP has the quality that Nestle requires for its Nespresso product. Nestle is well-aware of AFP’s capabilities. If AFP can gain Nespresso as a customer, that would be an important milestone.

Another significant growth opportunity comes from so-called stand-up pouches. These are used for pet food, food for people and can be more widely deployed. Manufacturing capacity has recently been expanded from 100 million annual production to 500 million and is expected to be increased further to 1 billion by the end of 2020. Reassuringly, demand for the massive increase in pouch production volumes has been secured before expansion was initiated, or it would be a major gamble with shareholders money.

The third growth leg is based on acquisitions. We believe that AFP is looking to further expand both geographically across Europe and the USA, following its existing customers as well as buying new ones. Also, it can vertically integrate in areas where it sees opportunities. It is our expectation that AFP will make at least one acquisition in 2020.

ESG

Our goal is to invest in companies that offer products and services that are part of the solution to the challenges our society faces. Packaging has been in the spotlight as being an important contributor to environmental pollution. Especially plastic is under assault. We understand the harm plastics can do to wildlife. What we like about aluminium is that it can be recycled indefinitely. Paper can be recycled just 5-6 times, after which the pulp must be burned or buried. Of all aluminium used in the world, it is our understanding that up to 75% is made from recycled aluminium.

The caveat is that it is to get truly reliable statistics for this.

AFP is the only company that has manufactured a coffee capsule that is made 100% from aluminium. This makes recycling easier. The capsules from Nespresso include a plastic seal. These seals make it impossible for a recycler to reuse the aluminium, unless they install equipment dedicated to processing Nespresso capsules. The result is that Nespresso capsules invariably end up in the ovens alongside other trash. For AFP’s fully aluminium capsules to be recycled, city councils must have modern equipment in place. This differs from city to city and from country to country.  In Germany and Austria for example, recycling is much further advanced than in countries such as Italy. The issue of recycling is widespread though. Many products we buy CAN be recycled, but very often are not.

When we first invested, Aluflexpack was still involved in packaging for tobacco. While this generated a low single-digit percentage of revenues, we were very unhappy with this. We have engaged actively with management to stop this activity as quickly as possible. By the end of 2019 already, management has stopped this activity.

The first annual report over 2019 contains information about how flexible packaging can contribute to a more sustainable product-packaging-system, highlighting it is not only about recycling but also about aspects like material intensity and effectiveness. Management is in the process of establishing measures for water consumption, CO2 emissions, etcetera across the group and subsequently will start reporting on these measures.

Innovation

Aluflexpack is continuously introducing smaller or bigger innovations for flexible aluminium-based packaging. Two highlights are its stand-up pouches and its coffee capsules.

In the link to the video, Aluflexpack clearly sets out its capabilities in stand-up pouches. The pouches AFP produces stand out in terms of the shapes it can produce to create a distinctive look in-store, which ultimately helps enhance the customers brand. Its innovative character is what helps AFP gain customers. It is in the process of ten-folding pouch production capacity to one billion units per year.

As stated above, the coffee capsules that AFP produces are the only such capsule on the market that is made 100% from aluminium. This significantly improves the ability to recycle the metal. There are alternatives on the market, such as plastic and carton-based capsules. These alternatives negatively impact the quality of the coffee. We believe that Aluflexpack will gain more coffee producers as customers in the next few years, offering significant growth potential that we have not yet included in our financial models.

Investment Case

The combination of the above factors addressed has assured us that Aluflexpack is a resilient business with good prospects. The difference between a good company and a good investment can be the price. Our fair value calculation indicated that the IPO price of CHF 21 was very attractive if the company can successfully execute on its growth initiatives and increase its profit margins as operational leverage kicks in. Management sees no reason it cannot achieve or even exceed operating profit margins in line with its best-in-class peers. In its guidance however, it applies the concept of ‘underpromise, overdeliver.’

If Aluflexpack proves it can achieve both revenue growth and higher profit margins, its current valuation will drop significantly below its peers. Positive earnings revisions in combination with a higher valuation multiple will then drive the stock price higher.

Since the IPO in June 2019, the stock price has remained remarkably steady. In March 2020, the stock rapidly declined by 50% from its high when coronavirus fears sent global stock prices plummeting. After full year results over 2019 were published, the stock price rebounded,  recouping almost all of the decline within five days.

Aluflexpack management communicated it is unaffected by the coronavirus. Actually, it sees multiple customers asking for more product. A disruption in sourcing raw materials would be a problem. AFP is part of the essential supply chain however. Food and medicines cannot be sold in stores without packaging. The food industry is working in cooperation with governments to ensure the avoidance of supply chain disruption.

Currently, only a few sell-side analysts write research about the company. Many investors therefore hardly know Aluflexpack. It remains largely under the radar.

We believe that as the company grows, it will start getting noticed. It is a process that will take time. The stock may linger for a long time and then suddenly spike, like what we saw with SilverCross holdings such as Varta, Apollo Alternative Assets and Panalpina. Or it can happen gradually. We don’t care. We are happy either way. At the time of writing, our calculation of fair value offers upside between 65% and 126% on a three-year time horizon.