Pact Group Asian Expansion Not Without Risk

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Packaging business Pact Group has signalled growth is heading in the right direction, as it acquires two major packaging operations in Asia and a bulk containers reconditioning business in WA.

-Stronger second half to be driven by full contribution from recent expansion/acquisitions
-Asia could be an important source of profit in the short term and its percentage of group revenue should rise significantly
-To narrow the discount to peers, Macquarie suggests Pact's top-line growth needs to be sustainable
 

By Eva Brocklehurst

Pact Group ((PGH)) has reiterated expectations for underlying earnings growth in the year ahead and announced the acquisition of major packaging businesses in Asia. The company has some early indications that organic growth is heading in the right direction, despite a slow start to the New Zealand dairy season.

Meanwhile, recent acquisitions and the Woolworths ((WOW)) crate pooling contract are performing to expectations, although energy costs have increased significantly. Morgans points out that the company has had to invest in efficiency programs to mitigate these costs while the company expects a positive $5-7m impact from its operational excellence program in FY18 should be of some help in overcoming rising energy costs and contract extensions.

Management now expects first half operating earnings to be broadly in line with the prior corresponding half, followed by a stronger second half that will be driven by the full contribution from recent acquisitions and crate pooling.

The latest acquisitions include the Asian packaging operations, ex Japan, of Closure Systems International (CSI Asia) and Graham Packaging Co (GPC Asia) from Reynolds Packaging for $142m. While there is potential for growth in Asia relative to more developed areas, brokers note this also comes with higher risk.

Macquarie was expecting FY18 to be a year of consolidation as the company has a number of recent expansions in terms of RPC and contract manufacturing to absorb. Hence, the latest acquisitions increase execution risk, given expansion is occurring on a number of fronts and in multiple geographies.

In the company's favour the broker notes there is a good long-term track record in relation to acquisitions. Macquarie calculates the Asian acquisitions have below-average margins at 12.6% for operating earnings (EBITDA) relative to the group average of 16% in FY17 but there should be an opportunity to improve the former over time.

The company will also acquire ECP Industries for $11.7m, a Western Australian intermediate bulk containers reconditioning business, which operates two sites, and believes this is an attractive entry point for this market.

CLSA believes the acquisitions will put to rest concerns that a stretched balance sheet is undermining the growth strategy. However, to meet forecasts still requires a robust second half. Although the businesses being acquired in Asia are likely to operate in markets that are relatively low growth, CLSA believes they will be an important source of profit for the company in the short term.

Given the critical mass the company will now enjoy in Asia, Asian revenues should rise to around $200m from around $50m currently, or to 12% of group sales from 3%. CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, has an Outperform rating and $6.20 target.

Deutsche Bank considers the Asian acquisitions slightly positive and the synergies reasonable, estimating the company will generate a pre-tax return on capital of 11.2% on the acquisitions.  Macquarie finds the valuation undemanding, but in order to close the discount to peers Orora ((ORA)) and Amcor ((AMC)) the company needs to demonstrate a sustainable return to positive top-line growth.

Asian Acquisitions

The Asian platforms are regional leaders in supplying plastic closures and plastic bottles to blue-chip customers in the carbonated soft drinks and health supplements/nutrition industries in Asia. CSI Asia features plastic closures design and manufacturing, with high-speed capping equipment/applications.

GPC Asia produces plastic bottles via injection and extrusion blow moulding using HDPE. The businesses encompass seven manufacturing sites across China, South Korea, Nepal, India and the Philippines.

The acquisitions will be funded via a fully underwritten, 1-for-9 non-renounceable entitlement offer at $5.28 a share to raise $176m. Major shareholder Kin Group and related entities have committed to take up the full entitlement of 39.3% of the offer. Net proceeds will be used to fund the acquisitions, cover costs and provide flexiblity for further investment in growth.

FNArena's database shows five Hold ratings and one Buy (Deutsche Bank). The consensus target is $5.78, signalling -0.5% downside to the last share price.
 

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