I meet Graham Chipchase, the chief executive officer (CEO) of FTSE 100 beverage can maker Rexam (REX), in the firm’s London offices at Millbank, within touching distance of Westminster Abbey. The building which houses its HQ has the slightly faded grandeur of a once grand hotel and I wonder if the group itself has lost some of its lustre in the wake of its summer (25 Jun) profit warning.

I kick off our chat by asking the bespectacled Chipchase if a long-touted return on capital employed (ROCE) target of 15% by the end of this year is intact despite the first-half difficulties: ‘Our ROCE target remains 15%,’ is his unequivocal response. ‘That doesn’t mean we’ll now look to achieve 18% by 2016,’ he continues. ‘We are at a level where we are achieving a 50% premium to the cost of capital. We don’t want to be excluding growth opportunities just to sit at 15%, but will it get back to 10%? No it won’t.’

Rexam produces aluminium cans for the likes of Coca-Cola (KO:NYSE), Carlsberg (CARL:CPH) and Red Bull and Chipchase admits that despite being a real British manufacturing success story it is not a well known one. He had not heard of the company when first approached by a head hunter a decade ago.

While a higher profile might help attract staff, he cautions that there are potential downsides for a firm seeking the limelight: ‘I’m not that comfortable doing it, it tends to get very personalised around the chief executive. The success of Rexam is not just down to me it’s down to all the people in the company.’

Market share pressure

Success is perhaps not the word for the firm’s performance in 2013. The main factors behind its struggles appear to have been capacity constraints in Brazil and increased competition in Russia. I ask Chipchase if these issues could have been handled differently.

‘The vast majority of problems in the first half come from GDP (gross domestic product) related or weather related issues,’ he responds. ‘In Brazil our biggest customer is losing market share and we had some issues around capacity for speciality cans. We’ve addressed that now which is important going into a World Cup year.

‘In Russia we had a 90% market share, we knew that was unsustainable and it subsequently fell to 80%. We are now at 70% and we need to decide if we will defend market share by agreeing supply contracts at a better price to maintain our position in a highly profitable market. In any case market share doesn’t erode very quickly.’

He adds that there are barriers to entry in the Russian market, not least the distances you have to cover - with its cans being shipped as far as 1,500 km from the Urals out to Siberia.

The CEO denies the three Cs strategy of optimising cash, controlling costs and concentrating on return on capital has resulted in the firm missing expansion opportunities. ‘I can’t think of an opportunity we’ve passed up because of it. We needed that focus to get us out of the position we were in in 2009. In terms of the transition from a value to an income story, cash generation is really important.’

It comes as a relief when the boss says dividends are his preferred way of rewarding shareholders and confirms he will look to maintain dividend cover of around two to two-and-a-half times. ‘If you have a lot more cash you can do a special dividend or if you just have a little bit you can buy back shares.

‘We may look at small bolt-on acquisitions and we continue to chase organic opportunities,’ says Chipchase. ‘We have a strong position in the BRIC (Brazil, Russia, India and China) economies but we are looking at other emerging markets - that’s where the growth is coming from.’

My assertion that a focus on emerging markets has drastically increased the risk profile of the business is strenuously denied: ‘We’ve been in Russia for two decades, Brazil for nearly two decades. In terms of political risk - despite the instability in Turkey and Egypt we have not seen any impact there. If we took a significant position in sub-Saharan Africa, that would increase the level of risk. In terms of currency risk it is purely translational. We don’t ship products across borders because of the freight efficiencies.’

I ask how Rexam is getting on in India, which Chipchase has identified as a key target market in the past and where it has first-mover advantage. ‘In India the progress has been great - it’s a small market, less than one can per head per year compared with a can per head per day in North America, but we’re seeing some very impressive growth from a low base.’ As he explains the use of aluminium cans is linked to GDP per capita and the size of the middle class.

I ask why greater emphasis isn’t therefore placed on the Chinese market given the country’s growing middle class. ‘China is an over-supplied and fragmented market,’ is his honest response.

With aluminium such a large part of the cost base, exposure to volatile raw material markets is carefully managed such that price movements are almost entirely hedged: ‘Our exposure to the aluminium price is negligible.’

The can market is heavily consolidated and Rexam’s main competitors, Ball (BLL:NYSE) and Crown (CCK:NYSE) are based in the US. Though the group operates in a competitive industry its nature means competitors are unlikely to act ‘irrationally’ in an attempt to grab market share, says my subject.

Rexam is in the process of becoming a more focused company having completed the sale of its personal care division for £452 million in January. The underperforming healthcare division, which manufactures syringes, asthma inhalers and other packaging products for the pharmaceutical industry, is next on the block and while Chipchase indicates questions about the divestment strategy are off limits I push ahead all the same.

I ask whether, after the healthcare sale, the group will not end up entirely exposed to what is essentially a commoditised product. After all even if there is increased emphasis on speciality cans, with customised cans of different shapes, sizes, colours and textures, surely there is only so much value-add to be achieved on what is a fairly basic piece of packaging.

‘A can is seen as a more commoditised product but we can add value by producing it extremely well, at the lowest possible cost and with flawless execution,’ contends Chipchase.

GDP plus some

Rexam has identified itself as being ‘GDP plus a bit’ at the topline level and a ‘GDP plus-plus’ at the operating profit line by leveraging capacity utilisation and offsetting costs with price increases and efficiencies. Efficiency is clearly key, August’s interims revealed a utilisation rate across the firm’s facilities in the low nineties, is this optimum?

‘The ideal utilisation rate is around the mid 90s,’ says Chipchase. Beyond this level, he explains, there is no time to carry out maintenance which would in turn have an impact on efficiency. ‘Utilisation will always be lumpy because if a market is growing it can take two to three years to add the necessary capacity’.

My next line of questioning concerns the firm’s performance on margins with return on sales in the beverage cans business dipping slightly in the first half to 11% from 11.4% in 2012. He insists this is not a red flag: ‘The return on sales or margin is not the best measure because if the price of aluminium goes up then sales increase and profits stay the same. This is why we use return on capital employed instead. You would expect a packaging company’s return on sales to be between 10% and 15%.’

Meanwhile Chipchase does not see a lack of diversification in the customer base as a significant issue. ‘I don’t mind being exposed to Coca-Cola it’s a great position to be in’. He insists the group has a ‘good relationship’ with the soft drinks giant after losing volume from it in 2010. ‘We have not lost a significant contract in the last three years. One of our largest customers for a very long time, with whom we have an exclusive relationship, is Red Bull.’

BIOGRAPHY

Graham Chipchase
Chief executive officer

The Manchester United fan and chemistry graduate joined Rexam as finance director in 2003 and took the top job in 2010. Previously he had been finance director at GKN’s aerospace business.

INVESTMENT CASE