Pact Packs Potential

This story features PACT GROUP HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: PGH

-May walk on Dynapack
-Acquisition discipline
-Losing rigid share in Australia?
 

By Eva Brocklehurst

Packaging company Pact Group ((PGH)) delivered on guidance issued at its IPO last December but there were two more important factors which pleased brokers – debt reduction and cash conversion. This underpins management's credibility, despite any weakness emanating from the challenging macroeconomic environment. Moreover, the suggestion that acquisition of Dynapack, which is under consideration, may not meet financial criteria was also welcomed, signalling management is prepared to be disciplined regarding acquisitions.

UBS welcomes the possibility Pact may walk away from Dynapack, having concluded that paying more than eight times earnings for that company would be dilutive to value. Pact's option on Dynapack is due to expire in December. Guidance for FY15 does imply a weaker outlook in Australia but that is offset by better margins in the international business. UBS likes the stock, expecting 7% growth in FY15. Pact has relative valuation appeal, as it is trading at a 20% discount to a basket of defensive industrials and has a strong yield. The broker believes there is scope to leverage the balance sheet with acquisition-led growth going forward. Using Pact's targeted 20% hurdle rate, acquisitions would provide 4% annual accretion to the broker's existing forecasts.

The share price has rallied strongly since July and Credit Suisse downgrades to Neutral from Outperform on that basis. Top line momentum was below expectations but Credit Suisse remains positively disposed to the stock. The business is diversified and evidence of sustainable top line growth could take the group forward to the next milestone. The broker also hails the discipline shown regarding the Dynapack acquisition, which may allay concerns regarding the influence of Pact's chairman, who owns 50% of Dynapack.

Credit Suisse observes the company's aspirations to become a $5bn, five region, company in five years time does not mean investors should be put off by fears Pact may try to swallow large acquisitions. The company has demonstrated a commitment to accretive returns and the broker assumes no big packaging asset would be sold at a multiple that is low enough for Pact to maintain its targets. This is most probable, considering Pact has little in the way of material synergies outside of Australasia, while low interest rates have inflated packaging asset valuations. On reflection, the broker considers Pact is more likely to be acquired, or merged into a larger company.

While believing there was always limited risk to prospectus forecasts, CIMB also considers the FY14 results characterise management's cautious approach to acquisitions. CIMB suspects this will broaden the pool of potential investors and narrow the discount relative to fundamental valuation. The broker acknowledges related party arrangements remain a part of the business, and an acquisition of Dynapack would likely require an equity issue, but remains confident that management can effectively manage these risks.

Management has highlighted the recent greenfield investment in Indonesia provides organic growth opportunities. Credit Suisse is seeking more information on the size of this revenue opportunity before factoring it into forecasts. Pact expects its Indonesian factory will yield revenue in FY16. Credit Suisse models 0.5% organic growth in Australia and 2.5% for the international segment. FY15 should be underpinned by the integration of Cinqplast, Pact China and Sulo.

Australian FY14 contributions were affected by the loss of a milk bottle contract and subdued sales in the agricultural segment. Pact also recently upgraded its thin-walled tub manufacturing, adding new volume. Credit Suisse seeks some clarity on what may be holding back Pact's rigid plastics volume growth in Australia. The broker has some suspicions that Visy, a well capitalised competitor, is adding rigid plastics capacity and may have won some market share. It appears volume went backward in New Zealand as well. Credit Suisse expected the company would have captured revenue growth from price increases that were undertaken to recover resin costs.

Macquarie believes the stock is cheap but has made a solid start in building a track record as a listed company. Pact is trading at a 19% discount to Orora ((ORA)), a listed domestic competitor. Macquarie observes Orora has stronger near-term earnings growth but Pact has higher returns and margins.

FNArena's database has four Buy ratings and one Hold. The consensus target is $4.29, suggesting 12.9% upside to the last share price. The dividend yield on FY15 and FY16 forecasts is 5.4% and 6.0% respectively.
 

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