Amcor’s demerger of Orora will list one day after the IPO of Raphael Geminder’s PACT Group, drawing attention to the packaging industry as an investment opportunity. Each offers its own attractions but investors should not forget the existing investment in Amcor itself, which will become an even better business post demerger.
That almost implies that Orora is not worth owning, but that is not so. Orora offers a more placid opportunity that may suit investors comfortable with a lower relative growth but offset by steady income.
Same, same but different
Amcor’s demerger of its Australasia and Packaging Distribution Division, to be known as Orora, will list on the ASX on 18 December. Amcor shareholders will receive one Orora share for each Amcor share owned.
The demerger booklet has been released to shareholders explaining the details of the demerger, together with the pro forma financial statements and an Independent Expert’s report that recommends shareholders approve the proposal.
Amcor (AMC)
The Independent Expert report from Grant Samuel had some interesting things to say about why the demerger was good for shareholders, but it used careful language.
For example, Grant Samuel noted that “it is highly likely that capital resources will be directed towards the much larger Flexibles and Rigid Plastics businesses in which Amcor enjoys global leadership.” Does that imply that the returns on future investments in the Amcor businesses will be better than those in Orora?
Grant Samuel also points out that future capital management decisions will be easier to make if Orora is a separate company to Amcor as its management will be singularly focused on Orora’s business, without the distraction of the flexibles and rigid plastics business competing for attention.
That may be true but it really becomes a question of the cost of capital and the expected excess return on that capital from each investment. If Orora’s excess return is less than the opportunities in flexibles and rigid plastics, as perhaps implied, then it will struggle to gain approval for some investment opportunities under the existing Amcor umbrella.
But that has not stopped Amcor investing over $700 million in Orora over the last three years to restructure and strengthen the business, as Grant Samuel notes.
Focus on quality
Orora’s business will be focused on fibre packaging and beverage packaging in Australasia and packaging distribution in North America. The revenue split will be approximately two-thirds in Australasia and one-third in North America, generated from 36 manufacturing plants and 79 distribution centres.
The gem among the manufacturing plants is the brand new recycled paper plant in Botany, which was initially commissioned in October 2012. It will take up to three years before it is really humming, but this machine will give Orora a significant advantage through its outstanding energy and water efficiency, plus the reduced waste to landfill. Annualised cost reductions of about $50 million are expected.
Orora’s customers will get a big boost from the high quality products that it will make.
One point that stands out across the Board and Management of Orora is its depth of experience in the fast moving consumer goods industries as well as basic manufacturing. The packaging industry is a critical supplier to fast-moving consumer goods (FMCG) businesses, so having empathy for the customers’ requirements is clearly beneficial to the business.
Important factors that drive the earnings of the business include volumes of product sold across various industries, as well as the raw material costs of inputs.
The very heavy investment in the Botany recycled paper machine (known as B9) has impacted the overall cash flow of the Orora business in the past three years. Excluding the B9 investment, annual cash flows have been reasonably solid, increasing from $127 million in the 2011 financial year to $160 million in 2013. As the B9 investment is now largely complete, reported cash flows will begin to normalise subject to the new board’s plans.
The balance sheet will have net debt of approximately $700 million, supported by shareholders equity of $1,300 million.
The Scheme Booklet does not provide any forecasts of expected earnings for Orora. That probably reflects the fairly fragile earnings environment in recent years, which is not specific to the company. However, that leaves investors less certain about the immediate prospects for the company post-demerger.
The competition
The PACT Group is being listed with broadly similar financial metrics as Orora but its business is mainly in rigid plastics, so does not directly compete with Orora. On a PE ratio of 13.4 times, the estimated FY14 net profit of $83.5 million and a 8.5 times multiple of FY14 operating earnings, PACT Group is no bargain at the indicated issue price of $3.80 per share, but it will provide an interesting contrast to Orora.
Demergers can sometimes be perceived with a degree of suspicion as to the motive of the parent company. Investors are inclined to think that if the demerged entity is a good enough business, why is the parent company untethering it?
Various examples of past demergers provide a mixed range of experiences for investors left holding the spin-off, while the parent company has generally appeared to be a leaner and better company than pre-demerger.
That does not mean that demergers are a bad thing, as each should be treated on its own merit.
Orora will commence its listed entity status as a financially sound business with steady earnings, capable management and reasonable prospects, as economic activity picks up and the benefits of cost reductions gradually make a contribution.
The dividend outcome will be similar as under Amcor, but will begin to accumulate franking credits from its beginning zero balance.
The post-demerger Amcor business looks the way to go and should be a core portfolio holding.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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