Orora Has Scope To Pursue Growth

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Packaging company Orora has considerable scope to pursue both organic growth and acquisitions, having delivered an FY17 net profit that was ahead of most forecasts while maintaining a robust balance sheet.

-Company expected to combat rising input costs and deliver improved margins
-Higher NSW electricity costs for B9 should be mitigated by benefits from water treatment plant
-Glass business experiencing increased demand from the wine bottling industry
 

By Eva Brocklehurst

Packaging company Orora ((ORA)) has considerable scope to pursue both organic growth and acquisitions, having delivered an FY17 net profit that was ahead of most forecasts while maintaining a robust balance sheet.

Brokers observe North America was the main driver of the buoyant result, with operating earnings growth of 23% in US dollar terms. Management has noted economic conditions in North America are flat and the market has settled after a lift in confidence early in the year. Meanwhile, Australasia was strong despite the headwinds from costs, emanating from both electricity and old corrugated cardboard (OCC) raw material input.

Costs

Concerns around costs led the market to retain low expectations leading into the result and brokers observe a strong share price reaction as a result.  Ord Minnett suspects some investors would have breathed a sigh of relief as the result demonstrated an ability to combat rising input costs and deliver improvement to margins. The broker envisages considerable upside to forecasts if the company can flex a healthy balance sheet and achieve its targeted return rates.

Deutsche Bank is a little less upbeat about the upside and believes the market will begin to focus on the impact of higher electricity and OCC costs in FY18. OCC costs increased in the second half and remain at higher levels, which should adversely affect earnings in FY18. This is a primary input for the company's B9 mill in Botany and the business is exposed to approximately 400,000 tonnes of OCC.

Deutsche Bank remains of the view that higher OCC costs and liner board prices in the US will have a negative impact of around -$8m. There are some offsetting benefits to earnings from higher export prices to both the US and Asia.

The company has reiterated that higher electricity costs in NSW from January 2018 will affect earnings and brokers observe a high degree of volatility and uncertainty remains over the Australian electricity market, which is expected to continue for the foreseeable future.

Deutsche Bank estimates the adverse impact at the company's B9 plant in FY18 is -$6-8m because of the legacy electricity contract expiring in December. This should be partially offset by the benefits from the secondary water treatment plant once it is commissioned.

Credit Suisse upgrades estimates by 1-2% and calculates the new biogas/wastewater treatment plant, to be completed in FY19, will reduce energy and waste costs by around $5m, and proceeds from the closure and sale of the Smithfield corrugated facility should largely offset the associated capital expenditure.

The broker has become more optimistic about the operating environment, notwithstanding the higher costs. The meat sector, which is a high-value box user, should no longer be a drag on sales in FY18 and Credit Suisse suspects it may even grow in FY19. In North America the synergies from previous acquisitions are expected to accumulate.

Acquisitions

The US business performed well but was out of focus amid the domestic concerns and Macquarie notes the impressive metrics in that geography along with expanding options on the balance sheet. The company appears amenable to larger acquisitions in the US, although is expected to remain disciplined.

Macquarie expects the company to be active in the point-of-purchase segment over the next six months, with the capacity to comfortably invest $150-200m per annum in growth initiatives.

Morgan Stanley was encouraged by the expansion in margins in both North America and Australasia. The broker believes strong operating cash flow and under-geared balance sheet support the growth strategy. Current business initiatives may mean some slowing of execution on mergers in the short term but the broker still expects accretive growth in the medium term.

Positive momentum from expansion, increased glass volumes and the full benefit acquisition should materially outweigh the negative impacts of higher energy and OCC costs, in the broker's opinion.

UBS raises FY18-19 forecast for net profit by 1-2% and already factors in the new glass capacity upgrade at Gawler, which will begin to contribute from FY18, as well as a full year benefit of acquisitions in North America.

The company is expanding its glass bottle capacity at a cost of $42m, noting the glass business is experiencing increased demand within the wine segment, driven by the repatriation of wine currently bottled offshore for bottling in Australia. Deutsche Bank considers this expansion a minor positive and believes acquisitions will be on hold for the next six months, pending the rolling out of the OPS ERP system and the integration of the Visual acquisition.

UBS envisages 6% growth in operating earnings (EBITDA) through FY18 and Australasia still growing by 2% despite the cost-related challenges. The broker believes investors will require patience to realise further acquisition-led growth, given a current focus on integrating prior transactions. There are five Buy ratings and three Hold on FNArena's database. The consensus target is $3.20, suggesting 7.3% upside to the last share price.

Disclaimer: the writer has shares in Orora.
 

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