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Orora Finds Growth In A Subdued Market

Australia | Feb 26 2015

This story features ORORA LIMITED, and other companies. For more info SHARE ANALYSIS: ORA

-Acquisitions, capital options
-Attractive versus Oz peers
-Botany mill ramps up

 

By Eva Brocklehurst

Packaging supplier Orora ((ORA)) impressed brokers with a solid first half result, growing its earnings base despite the lack of support from a subdued market backdrop. Full year guidance was very general, with earnings expected to be “higher than reported on a pro forma basis in FY14”. Orora was spun out of the Amcor ((AMC)) group in December 2013.

Macquarie found the results hard to fault. Benefits are forthcoming from the Botany mill ramp-up while margins are ahead of expectations, driven by cost cutting efficiencies in manufacturing as well as market share gains. All the benefits are coming despite a lack of support in the external environment, with demand conditions notably subdued across the company’s markets. The broker observes a growing focus on innovation, reflecting a conscious need for sustainable earnings growth as cost cutting benefits run their course.

On the negative side, franked dividends are now more likely to come in FY16 rather than the second half because of the timing of tax payments. The Australian market is still very flat and North America is yet to show tangible improvement. Still, Macquarie envisages 14% compound earnings growth over the next three years, coupled with balance sheet options around acquisitions or capital management. The stock is not cheap but Macquarie believes the valuation is justified by its defensive growth attributes, as it offers leverage to the US economy and a weaker Australian dollar, with solid yield and balance sheet options.

UBS retains a Buy rating and considers the stock attractive when viewed relative to its defensive Australian industrial peers. Given the improved performance of the Botany plant over the past six months and margin enhancement, the broker believes visibility around growth estimates is much clearer. There is scope for acquisitions or capital management and the broker retains a dividend profile pay-out at the upper end of management’s 60-70% target range. That said, UBS observes total capital expenditure is still above the historical average, driven by the investment in glass furnace realignment at Gawler, investment in a dairy sack line and a new ERP software system for the North American business.

Confidence in the company has improved and Credit Suisse upgrades to Outperform from Underperform. The broker expects further re-rating because of the stable outlook and yield compression. Rising gas costs will feature in the second half and beyond, while refurbishing of a glass furnace will initially impact profits. Still, glass revenues are expected to benefit from new contracts and Australian data shows wine bottle export volumes have returned to growth.

In terms of gas supply, Credit Suisse observes Orora has an option with Strike Energy ((STX)) for the sale of 45PJ over a 10-year period from 2017 at an attractive fixed rate. While the gas provider is still in the early stages of development, the fixed rate is deemed favourable and Orora could obtain a substantial reduction in gas costs if Strike Energy is successful. Obviously, the broker is not yet factoring in this scenario.

What is more certain is that a lower Australian dollar and the quality of the paper coming out of Botany means the forest/Kraft pulp market in North America should find a ready substitute in the local product. Concerns around the performance of the Botany liner board mill were always overdone, in Citi’s view. Citi observes the mill is on track to meet its FY15 target of 360,000 tonnes and further export sales to the US are likely. The first half performance should go a long way to easing concerns, in the broker’s opinion. Deutsche Bank was also upbeat. Cash flow was in line with expectations and the balance sheet much improved. Deutsche Bank retains a Hold rating as the stock is trading at a 9.0% premium to the broker’s valuation.

Morgans was pleased with the company’s ability to take advantage of growth opportunities and the reiteration of an intention to deploy cash via acquisitions or capital management. While the stock is considered fully valued at current levels, cash deployment could mitigate uncertainty associated with future initiatives. Importantly, this could also provide a more sustainable basis of earnings growth. In the current uncertain environment the company’s relatively stable growth outlook should support the investment proposition, in the broker’s view.

FNArena’s database reveals Orora has three Buy ratings and four Hold. The consensus target is $2.16, suggesting 4.4% downside to the last share price. This target compares to $1.94 ahead of the results. Targets range from $1.81 to $2.50.
 

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