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In the last fortnight we initiated a 2% position in ORA, the leading Australasian producer of fibre, paper and glass beverage packaging. With >60% of earnings from defensive end markets, ORA’s stable earnings base provides predictable cash flows. Unlike many of its peers, it is able to grow both organically, through capacity reinvestment and operational expansion, and through M&A. Despite lower margins and ROE, ORA maintains a more conservative balance sheet, has good cash conversion and has superior growth prospects in the Australian wine industry and US Point of Purchase market.
Our thesis is:

  • Defensive earnings generated off a conservative balance sheet. ORA produces primarily for the fast-moving consumer goods sector, which is typically unresponsive to economic cycles. This allows the balance sheet to be run very efficiently, with a high degree of certainty around future cash flows. Gearing is also amongst the lowest in the sector.
  • Strong market position with high barriers to entry. ORA has leading market positions in Australia and New Zealand. Natural barriers through capital intensity, operational scale, distribution networks and scope of capabilities.
  • High consolidation potential in North America. ORA’s increasing free cash flow will likely be used to drive M&A in its distribution business in North America. ORA is likely to move further up the value chain through acquisitions of adjacent businesses.
  • >$400m of balance sheet capacity. With an underleveraged balance sheet, ORA’s reinvestment/acquisition potential is high. Upgrades to its B9 paper mill, bottle plants and US distribution network, are all channels to growth that are currently open.
  • Glass bottle demand outstripping supply, primarily as a result of strong growth in Australia’s wine industry. ORA currently faces a supply deficit of 100m bottles p.a. which is being met through importing. It recently completed a $42m expansion to its Gawler bottle plant, and will likely require further reinvestment to meet future demand.

Downside risks:

  • Input price risk: volatility in the price of OCC is potentially a significant headwind to margins following the rollover of ORA’s next supply contract (FY19). Moreover, energy continues to act as a headwind, with domestic gas prices remaining at elevated levels. ORA already stands to record a FY18 energy cost uplift of $6-8m.
  • FX risk: with >50% of revenues being earned outside of Australia and growing leverage to US growth, ORA remains exposed to key exchange rates (AUD/USD and AUD/NZD).
  • Volume/market risk: Weaker domestic consumption of beverages, lower exports of wine to China and any major economic downturn are all risks to volumes. That being said, ORA has relatively non-cyclical earnings.
  • Acquisitions dragging on group profitability: ORA is forecast to be a market consolidator in the future. As a result, it will face significant acquisition risk. May be heightened if any large (non-bolt on) M&A is undertaken.
  • Cost savings risk: Management has guided to a fresh wave of cost-out and efficiency initiatives in the ANZ business. Failure to deliver would likely lead to consensus downgrades.

We accumulated a 2% position over two trades: we bought 2,262 shares at $2.73 on 7 August to make a start before the FY17 result, then 1,969 shares at $2.91 on 10 August, the day of the result. The investments were funded by sales of units in the BetaShares Australian High Interest Cash ETF (AAA), where we sold 39 units at $50.10 on 7 August and 114 units at $50.11 on 10 August.
The intention behind buying only half the ORA position before the result was to hedge against any disappointment. In the end the result was so strong we bought the rest of the position that day, as it was clear the stock would rerate further. So far ORA is one of the best results of the August 2017 reporting season. This was a solid beat of expectations and the outlook is positive notwithstanding cost pressures.

Figure 1. ORA FY17 result highlights
Source: ORA
Consensus NPAT was ~$180m, implying a 3.4% beat. Revenue was broadly in line with most estimates. The dividend payout ratio increased slightly to ~70%, the top of the 60-70% target range. Cash conversion as measured by operating cashflow to EBITDA (OCF/EBITDA) was 74% and leverage as measured by net debt to EBITDA was lower than expected at 1.6x and well below the target range of 2-2.5x.
In Australasia revenue grew 2.3% to $2001.6m due to strong growth in glass and wine, offset by weaker volumes in beverage cans. Volumes were steady in fibre. Efficiency and expansion projects assisted EBIT margin expansion of 50bp to 10.7%.
 

Figure 2. ORA FY17 Australasian result
Source: ORA
In North America revenue jumped 11.4%, reflecting a mix of volume growth, share gains and acquisitions. EBIT grew faster at 23.1%, a strong result benefiting from significant operating leverage, procurement centralisation and supply chain optimisation. However the EBIT margin is still only half of the A&NZ business at 5.4% and there is significant room for improvement as ORA expands up the value chain in less commoditised services.

Figure 3. ORA FY17 North American result
Source: ORA
We expect another year of solid growth in FY18, though as in FY17 (see Figure 2 above) ORA continues to face high and rising costs of recyclable cardboard, energy and soda ash prices, all key inputs. Not all of these extra costs can be passed on, so there could be margin compression. The healthy balance sheet can be deployed in the US, with the remainder used to driver further efficiency/cost savings benefits in A&NZ. 30/06/18 value is $3.14.