Avery Dennison Earnings: Persistent Inventory Destocking Creates Challenging Operating Environment

Narrow-moat-rated Avery Dennison AVY reported second-quarter results that were largely in line with our expectations. The company continues to navigate destocking trends in the apparel industry as organic net sales fell roughly 10% amid double-digit declines in volume. Additionally, adjusted operating margin contracted 200 basis points to 11.2%, largely due to lower volume that was offset by temporary cost reduction initiatives. Management noted that while destocking activity appeared to moderate during the quarter, the recovery was slower than anticipated. That said, we maintain our view that destocking trends will soften in the second half of the year, which should relieve some margin and volumes pressures. We’ve decreased our fair value estimate to $142 from $144 per share due to lower near-term profitability in our forecast.

The materials group saw organic sales fall more than 11% year over year as persistent inventory destocking weighed on volumes. Management noted label volumes improved sequentially, but it was materially slower than they had originally anticipated just a quarter ago. The solutions group saw similar results during the quarter, with organic revenue declining 7% year over year and its adjusted operating margin contracting over 400 basis points. This was largely due to apparel destocking that weighed heavily on its base solutions business. Nevertheless, Avery’s intelligent labels business continues to perform well despite the current market conditions as nonapparel categories like logistics and food experience robust demand.

Management provided third-quarter adjusted EPS guidance of $1.80 (midpoint), but refrained from reiterating or updating its full-year guidance that was provided last quarter as persistent destocking and sluggish volume recovery increased near-term market uncertainty. While we expect some sequential improvements in inventory destocking, apparel will likely remain a headwind for both segments through the end of the year.