Beating Buffett

Avery Dennison Corporation (NYSE:AVY - $30.80) manufactures pressure-sensitive materials, office products and a range of tickets, tags, labels and other converted products. AVY also makes and sells a range of office products and other converted products such as binders, organizing systems, markers, fasteners, business forms, tickets, tags, radio-frequency identification (RFID) inlays and imprinting equipment for retail and apparel manufacturers. They operate three segments: Pressure-sensitive Materials, Retail Information Services and Office and Consumer Products.

2009 was a year to forget for AVY. EPS dropped from $3.30 to $1.97 (excluding a $9.18 /share charge for discontinued operations) and the dividend was cut from $0.41 to $0.20 quarterly. Even so, 2010 looks to be a recovery year. Estimates for 2010 range from $2.50 - $2.65 and for 2011 the consensus is centered on $3.00 per share.

The (already reduced) current yield is a decent 2.6% and is likely to begin rising again as the earnings ramp up from last year’s depressed level. AVY had shown improved year-over –year results in 11 of the past 15 years. The low 2009 quarterly earnings will make for easy comparisons as 2010 unfolds.

Here are AVY’s per share numbers from continuing operations as reported by Value Line:

Some things that jump out at me after looking over the chart:

1)     Avery Dennison clearly has ‘earnings power’ of $3 - $4 /share in a normalized economic period.

2)     AVY’s current P/E of a12.3x is well below any previous multiple (excluding the bottom of the 2008 – 2009 meltdown.

3)     AVY’s absolute share price is well below the lows from the entire 7-year period 2001 – 2007 and also significantly under the highs of market challenged 2008 – 2009 as well.

Avery Dennison is a healthy company. Value Line assigns them an ‘A’ for financial strength while rating them ‘above average’ for safety. Value Line also notes their 80^th percentile ranking for ‘stock price stability’ and a 70^th percentile ranking for ‘earnings predictability’ (with 100^th being best). Standard and Poors gives AVY a 4-Star rating (with 5-Stars being best).

AVY’s 10-year median multiple has been 20x while the average of the nine years on the chart above is 17.9 times earnings. A rebound to even 15x the low-end projected 2010 earnings of $2.50 would bring AVY shares back up to $37.50. That’s 21.7% above this morning’s quote.

If it takes a year to reach that goal you’d have a total return of almost 25%. Is that a rational target price? Sure. Standard and Poors carries a 12-month projection of $40 and Value Line is using a 16 multiple in figuring their 3 – 5 year share price projections.

I noted earlier that even during 2008 and 2009 AVY shares changed hands at above $40. They closed at $40.07 on January 9^th of this year as well. If anything, my expectation is likely too conservative rather than being over aggressive.

Summary:  Avery Dennison seems to offer very good risk/reward characteristics with well-defined upside of 20 – 40% and only moderate risk. The 2.6% current yield is better than what can be earned right now on most multi-year bank CDs or Treasury Notes.

****************************************************************************

Investors that are well-versed in options might want to consider writing (selling) some October 2010 puts on AVY. Here are some currently available premiums and their associated data points:

The margin of safety is the percentage drop from today’s $30.80 quote to your break-even price if the puts were to be exercised.

Disclosure: Author is long AVY shares and short AVY puts.