What's behind the sharp fall in Orora?
Shares of packaging solutions company Orora Limited (ASX:ORA) have fallen more than 17% on today's earnings announcement. In this wire, we look at why the share price has fallen so sharply and share our view of the next 12 months. We also look at how the company is positioned in regards to longer-term trends, something the market may be overlooking
Key takeouts from the report
North America was weak with deteriorating market conditions having a sharp financial impact in 2H19. North America EBIT was lower by 11.1% with the EBIT margin of 4.5% down by 110 basis points. The shortfall was mainly Orora Packaging Solutions, which faced lower volumes and input prices.
An element of broad packaging market weakness has been evident in other packaging company results from early 2019, however, OPS’s high exposure to California exacerbated this, where the market has seen overinvestment and consequent overcapacity lowering returns. This has the market questioning Orora’s M&A activity in the US but OPS’s expansion out of California and into Texas, through the acquisition of Pollock and Bronco, can’t come soon enough
The Australasia operational result more than offset cost inflation. The 6.2% growth in EBIT in Australasia carried the group EBIT to a 3.7% increase. Sales increased by 2.1%, 1.5 percentage points of which was organic and the balance pass-through of costs.
For this reason, the EBIT margin is a better measure of performance and it grew by 50 basis points to 11.5%. Cost inflation impact was more than offset by organic capex initiatives, favourable mix in beverage cans and volume growth in fibre packaging to food products. Seasonal conditions in fresh produce and reduced wine volumes in glass dragged on performance in what was a creditable result.
The outlook for Orora for the year ahead
In Australasia identified a number of cost headwinds, in aggregate approximately $11.5m and the impact of a major capital project in the glass furnace re-line of $8m. The business has consistently offset inflation with efficiency initiatives, organic growth and cost inflation pass-through, albeit lagged.
Ex the glass furnace re-line impact the business is expected to grow with favourable trends for beverage cans, new non-alcoholic beverage markets for glass and increased market position in fibre for food packaging. It may still be possible to achieve growth including the impact of the glass furnace re-line, but the cost impact will reverse in FY21 and its production capacity will also increase.
North America will be cycling a reasonable result in 1H19 but will have the benefit of the Pollock acquisition, the earnings of which are 70% weighted to the first half. In the absence of an improvement in market conditions, any underlying improvement will be driven by realising benefits of the new ERP system and the restructuring program which it enables, with most of the reduction in FTE’s to occur this month.
Weighing against these benefits will be any further deterioration in US markets, while the AUD is currently around lower on a 12-month basis, which assists earnings translation.
Well-positioned against the global backlash on plastic
The global “backlash” against plastic packaging has gained momentum in 2019. It is consumer-led but has been given impetus by governments on both the left and right sides of politics with regulatory commitments, including Australia.
The impact of plastic waste on marine environments and the emissions impact of plastic production are two elements which indicate this will be a long term phenomenon.
Orora’s focus on fibre, aluminium and glass positions the company well for medium-term consumer and regulatory push against plastic packaging and its focus on technology will assist customer substitution of more renewable and recyclable substrates for plastic.
Australia’s 2025 National Packaging targets adopted by state and federal governments under the Australian Packaging Covenant Organisation include 100% of packaging to be reusable, recyclable or compostable. Other 2025 targets include 70% of plastic packaging being recycled or composted, 30% recycled content included in packaging and the phase-out of single-use plastics packaging.
Paperboard recycling rates run at more than 72%, with aluminium cans at 72%, while plastic is approximately 32% (APCO Packaging Material Flow Analysis, February 28 2019). Efficiency of collection, sorting, recovery and local material utilisation rates for non-plastic packaging are 2-4 times that of plastic.
By substituting fibre for plastic where possible, APCO’s 1400 members, which include the largest consumer companies in the country, can respond to consumer preferences and more rapidly meet their annual targets and ultimately the strategic goals to which they’ve committed to in becoming members of APCO.
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Richard co-manages Blackmore's Blended and Income portfolios and brings more than 24 years experience in financial markets encompassing equities research and portfolio management at Argo Investments, Antares and AMP Capital.