Australia | May 02 2019
Packaging business Orora is reviewing its cost structures after a slow start to 2019, although brokers consider the business well-placed in a softening economy.
-Glass volumes are lower in Australasia while fruit packaging is strong
-No material impact from electricity prices expected in the near future
-Valuation justified by defensive growth attributes and strong balance sheet
By Eva Brocklehurst
2019 has started off slowly for Orora ((ORA)), with the weakness primarily stemming from a US government shutdown and weather affecting North American business. Of note, the company has experienced an improvement in March and April. North America represents 36% of the company's FY19 earnings.
In Australasia there are signs the economy is slowing, although the signals are mixed for short-term demand. Glass volumes are lower, as wine exports to China weaken, while fruit packaging is strong. Adverse weather in Queensland had a minor impact over the March quarter. Macquarie points out April sales were in line with, or just ahead of, expectations despite the uncertainty.
As a result, cost structures are being reviewed, in both Australasia and the US. The company is integrating recent acquisitions and, once these costs roll off fully, Morgans expects the North American performance will improve.
Recent cuts to US paper prices are not expected to have a material impact, which Citi believes is because of lower OCC (old corrugated cardboard) input costs, which may have provided a greater benefit had the company not locked in higher fixed-price contracts. Other inputs, such as kraft paper and starch, are expected to remain a headwind in the second half.
Renewable energy agreements that were entered in FY18 are providing greater certainty for electricity costs and the company is not expecting a material impact from electricity prices in the near future.
In relation to gas, Orora has signed an initial two-year agreement with Senex Energy ((SXY)), commencing January 1, 2020. The gas will be supplied at a fixed cost in line with current market levels and indexed annually. Citi estimates current market prices for the gas are in the low $9/GJ, around $ 2/GJ higher than Orora's legacy contracts.
The broker calculates this implies a significant $7.0m per annum of additional energy costs from January 2020. With Orora requiring 5.0PJ of gas annually, Citi expects it will announce further contracts in coming months.
The company continues to expect constant currency earnings to be higher in FY19 than FY18. While the economy is tougher to negotiate, brokers point out Orora operates in relatively defensive areas of food and beverages. Morgans asserts the high-quality, defensive business with a strong balance sheet means recent share price weakness offers an attractive entry point for long-term investors.
Macquarie also considers the stock's valuation is justified by the defensive growth attributes and strong balance sheet. The broker does point out that a recovery in US earnings is an FY20 story, although recent demand and peer results in the US are notably subdued.
The company continues to focus on sustainability, and to this end is performing trials with plastic replacements such as fibre. Sustainable packaging initiatives include fibre trays, fibre punnets and fibre bubblewrap.
Meanwhile, the Pollock and Bronco acquisitions are tracking to plan and the company's priority is to settle these before making any further acquisitions. Beyond this, with plenty of deployable capital, M&A will focus on North America, and Mexico is also an attractive location Macquarie suggests.
FNArena's database shows three Buy ratings, four Hold and one Sell (Morgan Stanley, yet to comment on the update). The consensus target is $3.48, suggesting 13.3% upside to the last share price. Targets range from $3.20 (Morgan Stanley) to $3.92 (UBS, yet to comment on the update). The dividend yield on FY19 and FY20 forecasts is 4.3% and 4.6% respectively.
Disclaimer: the writer has shares in the company.
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