Australia | Aug 17 2016
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After a strong FY16, brokers laud the outlook for packaging company Orora, which is targeting organic growth as well as further investment in innovation and acquisitions.
-IntegraColor providing opportunities in US PoP market and vertical integration
-Australasian cost benefits on track, with lower AUD delivering tailwinds
-US target market fragmented, with small bolt-on acquisitions more likely
By Eva Brocklehurst
Orora ((ORA)) has deftly packaged broker confidence in its outlook, with FY16 results that were driven by strong organic growth, cost reductions and the contributions from recent acquisitions. FY17 earnings are forecast to be higher, with the company targeting organic growth as well as further investment in innovation.
North American acquisitions contributed heavily to the result, providing market share gains and margin expansion, while Australasia benefitted from improved volumes and cost improvements despite generally flat conditions. The company established two new distribution centres in the US and increased its glass forming line capacity in South Australia. The acquisitions of Jakait, IntegraColor and a Californian supplier of flexible packaging were also completed.
UBS believes there is further upside potential for the company, expecting Orora should deliver around 10% growth per annum over the next two years with reasonable confidence. Scope to pursue its acquisition-led strategy in North America also continues, as net debt is expected to moderate to 1.4 times earnings by the end of FY17. The broker expects that deploying capital in North America will create long-term shareholder value.
While the market may have largely factored in muted organic growth for the domestic business, UBS envisages potential margin accretion over time, underpinned by a duopoly industry structure in fibre and glass industries and a sustained lower Australian dollar providing tailwinds for domestic exports such as wine.
In North America, the broker envisages IntegraColor is more than just a printing business but will provide an entry point and further exposure to the fast-growing convenience channel. Over time UBS believes IntegraColor provides an opportunity to vertically integrate the entire packaging value chain, from design to procurement to logistics and marketing.
Morgans is increasingly confident in the company’s ability to drive organic growth, extract operational efficiencies and execute on acquisitions. The stock is not cheap, hence a Hold rating, but the broker believes it deserves a premium multiple given its defensive characteristics and strong market position.
Citi also remains a holder of the stock because of the benefits of the robust earnings outlook, attractive cash flow and highly regarded management. The broker considers the stock’s multiples already reflect this to a large extent so upside from current levels may be driven by events.
The results were almost faultless, Ord Minnett contends, expecting the delivery of top line synergies and further acquisitions, particularly in the point-of-purchase (PoP) area, which offers scope for earnings upside. Given the share price spike in the wake of the results the broker reduces its recommendation to Accumulate from Buy.
North America delivered underlying revenue growth of 6.0% and management remains confident in its ability to deliver growth at a rate of twice GDP. Ord Minnett notes further investment will be required to achieve this growth but, with cost increases tracking below revenue growth, this paves the way for margin expansion. Ord Minnett now assumes North America reaches a peak margin of 6.0% by FY22.
In Australasia, while the company is on track to deliver the benefits of its cost savings from the B9 paper mill, Ord Minnett notes electricity, gas and soda ash input costs will likely experience continued pressures into FY17. Earnings growth will therefore depend on organic sales and operating efficiencies. The Australasian business margin is expected to gradually improve to 11.3% by FY22.
Macquarie was also impressed with the results. The broker has run a re-investment scenario to quantify the potential earnings impact from the balance sheet options. Management envisages $100-150m per annum in deployable capital. Assuming targeted returns of 20% are delivered over three years the broker calculates there is 10-21% in theoretical upside to profit forecasts by years four to five.
Macquarie also notes the acquisition of IntegraColor has strengthened the company’s offering and improved its ability to participate across the customer value chain. The company has stated IntegraColor provides a new path for growth in PoP and targets are being developed, with the next stage being to expand the US geographic footprint from its current holding in Texas.
Credit Suisse observes the company may have US$300-400m of firepower for acquisitions, which could potentially add over 10% to earnings, but there are few targets which could consume that capacity. IntegraColor holds a 1% market share in a fragmented US$10bn market, the broker notes, with the top four holding just 20% of the market. All up, Credit Suisse believes Orora may need to string together several small acquisitions rather than make a “transformational” deal and the earnings contribution from each would only be modest.
FNArena’s database has five Buy ratings and three Hold. The consensus target is $3.08, suggesting 2.8% downside to the last share price. Targets range from $2.75 (Deutsche Bank) to $3.40 (UBS).
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