I bought some coffee pods recently from a specialist provider. They were packaged in a coffee “sleeve”, which was packaged again with other sleeves, and put in a trendy oversized bag.
The packaging looked great but had four layers when two would have done, not to mention the issues around coffee-pod recycling. Excessive packaging these days is a bad look for brands.
Later that day, I bought vegetables from an organic grocer. True to form, I forgot my own bags and the grocer reluctantly gave me a cardboard box, accompanied by an “eco-criminal” stare and raised eyebrow. Single-use packaging is the enemy in his store.
Heaven help me if I want to print this article to make corrections or put the wrong item in a recycling bin. My eco-obsessed family chide me about deforestation and the islands of plastic bags killing aquatic life. As annoying as that is, I’m glad they worry about such things.
Jokes aside, the move to reduce packaging in developed nations has huge implications for packaging providers. Consider supermarkets: a few years ago, an average grocery order came in half a dozen plastic bags. Now, it is in reusable bags or stuffed in one or two paid-for bags.
I see this trend as a long-term tailwind rather than headwind for high-quality packaging companies that can move up the production curve through innovation. Orora (ORA) looks the goods on this front and offers value after share-price falls in 2018 and early 2019.
To recap, Orora was born from the demerger of packaging giant Amcor’s Australian operations into a new listed entity in 2013. I follow demergers closely because they have a habit of outperforming (often after a tough first year) as standalone companies.
That has been true of Orora: the five-year average annualised total return (including dividend reinvestment) is almost 22%. But the return is down almost 7% over 12 months, principally on fears of tough US trading conditions, Morningstar data shows.
Orora produces glass bottles, aluminium cans, closures and caps, boxes and cartons, recycled paper and a range of rigid and flexible packaging. The $3.7-billion company is about a fifth of the size of former parent Amcor, which has a much larger global footprint.
As an aside, I wrote favourably on Amcor (AMC) for The Switzer Report in mid-2017. Amcor’s one-year total return is 23% but it looks fully valued after this year’s rally and its takeover bid for US packaging giant Bemis to create the world’s largest packaging firm.
Chart 1: Amcor (AMC)
Source: ASX
Orora made 59% of its sales in North America in the first half of FY19, the rest in Australasia. Unsurprisingly, Orora fell when management noted tough US trading conditions and when underlying earnings (EBIT) in that division were lower than expected.
Recent results from global packaging-related companies suggest sluggish US trading conditions. US giant 3M company had negative sales growth and UK distributor Bunzl also noted easing sales in its US operations and ongoing price deflation.
The US economy has a booming jobs market but recent industrial production figures there unexpectedly fell and the annual increase in March was the smallest in 18 months. After two negative months, it looks like slowing economic growth is affecting factory orders.
That suggests Orora will deliver low organic revenue growth from its US operations for the full FY19, amid flat volumes for its goods. The bear case for Orora – moderating organic growth in its US operations – is likely to persist well into this year, judging by recent trends.
Are market fears overstated?
Orora has many near-term challenges but they factored into the valuation at the current price, and then some. More on that later.
Orora said at the recent Macquarie Group Investor Conference that trading conditions, primarily in the US, improved in March and April after a slower-than-usual start to 2019. It’s likely the US Government shutdown in the first half of FY19 and bad weather affected packaging demand.
Orora expected tough US trading conditions to continue and saw mixed signals in its Australasia operation. But FY19 earnings guidance was maintained; judging by share-price falls this year, the market expected a profit downgrade. Orora shares rallied on the news this month..
There’s not much market/talk about an earnings recovery for Orora in FY20. Many analysts downgraded profit forecasts for its US operations after its interim result. That has set Orora up to rally later this year if its FY20 outlook improves.
Orora has much to gain from continued acquisitions in the US market that give it greater scale and capability to serve clients. Orora said its integration of Pollock Packaging, a Texas-based packaging and facilities supplier, is on schedule, as is that of another Texas-based packaging distributor, Bronco Packaging Corporation. Orora acquired both in 2018.
Orora has a strong balance sheet and current gearing levels are well below its target, meaning there is scope to buy other businesses in a depressed US market. If tough trading conditions continue, Orora should be able to buy packaging businesses in the US and Mexico at lower valuations and rapidly integrate them into its North American operations.
Longer term, Orora, like other packaging companies, will benefit from growth in e-commerce, international trade and the population. Consumers might prefer less rather than more packaging, but an increase in the number of shoppers will drive growth in packaging demand. Online shopping in particular will drive growth as packaged goods are shipped.
I like Orora’s innovation focus and have read about several of its initiatives. Smarter digital printing, produce trays and design concepts headline its innovation. Orora is even producing eco-friendly fruit labels and transforming those annoying stickers on apples and other fruit.
Orora has committed $75-million to its global innovation initiative to develop customer-led products and improvements in plant productivity for packaging. It’s more than public relations: consumers want eco-friendly packaging and companies are under pressure to deliver it. Innovation laggards in packaging will be left behind.
Valuation
At $3.08, Orora is on a forecast Price Earnings (PE) multiple of 16.8 times FY19 earnings, consensus analyst estimates show. The stock’s average PE was 19 in FY17 and FY18.
Macquarie in early May said Orora traded at a 22-24% discount to the average PE in the All Industrials ex-Financial index in FY19. That was the biggest discount in five years. Orora mostly traded at a small PE premium to the S&P/ASX 100 index over that period.
On a comparative stock basis, Orora’s PE is slightly higher than the average of its nearest listed global peers (a PE of 15 on Macquarie’s calculations). Orora arguably deserves a small valuation premium given its scope for faster earnings growth and balance-sheet strength.
An expected dividend yield above 4%, partially franked, is another attraction. It should provide some comfort if Orora’s recovery takes longer than expected to play out.
All bets are off if the US economy slows faster than expected and the Australian economy contracts sharply, requiring several rate cuts this year. But I don’t see either event happening and expect renewed strength in the US economy and continued modest growth in Australia.
Either way, Orora is trading well below its historic PE average, despite recent signs of trading improvement and offering a reasonable yield for a cyclical stock.
That looks like an okay entry point for long-term investors who understand the risks of investing in mid-cap cyclical companies with global operations. Orora is not screaming value, but it’s getting harder to find undervalued stocks after our share market’s rally this year.
Short of a takeover bid, there’s no obvious re-rerating catalyst for Orora in the next few months as the markets seek further confirmation of improving US trading conditions. But if you wait until the recovery in its US operations is obvious, early gains in Orora – now back at 2017 prices – will be over.
Chart 2: Orora (ORA)
Source: ASX
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 6 May 2019.