Packaging is a highly competitive and fragmented industry, with mature but predictable demand across most major markets. Most investors of packagers are attracted to their strong, stable cash flows, ability to grow through acquisition and solid yield. Certainly, these characteristics are enviable in the current uncertain economic environment, with weak consumer sentiment and very little growth outside of select industries. Our issue with packagers remains that they too are struggling to grow, despite trading at a premium to the broader market. We published a note to this effect last September, breaking down the growth of businesses such as Pact Group (ASX:PGH) to demonstrate that, excluding acquisitions, cost savings and efficiency programs, there was little to no organic growth.

The one exception to that conclusion is Orora (ASX:ORA), which has positioned itself to service growing industries such as Australian winemakers and the US point of purchase (POP) market. Australian wine demand has been strong enough to create a supply deficit of ~100 million bottles annually which are currently being filled through import contracts. In FY17, ORA invested $42 million into expanding the production capacity of its glass furnaces to fill the deficit, and it stands to be an attractive outlet for reinvestment over the medium term. Contrastingly, ORA did not previously have exposure to the US POP market and has been aggressively gaining scale following its initial entry via the acquisition of IntegraColor. Most recently, this included a smaller ‘bolt-on’ acquisition and subsequent rebranding of the combined offering as Orora Visual, which stands to be another conduit for return-accretive reinvestment over the medium-term.

 


Figure 1. ORA EBITDA bridge chart, FY14-FY18e
Source: Company reports, Clime estimates

Meanwhile, ORA’s B9 paper mill, its largest single asset, has increased production every year since listing, exiting FY16 near its designed capacity of 400,000 tonnes p.a. This additional production has been directed to the growing packaging solutions (OPS) and POP divisions and hence has not resulted in net group volume growth. Given both divisions continue to grow strongly, even if underlying external demand is flat over the medium term, ORA will likely need to expand its production potential through further reinvestment, yet another source of organic growth.
 


Figure 2. B9 paper mill production ramp up
Source: Company reports, Clime estimates

 

As its exposure to cyclically weak industries such as dairy, or the mature soft drink market, shrink over time with its shifting earnings mix, it is likely that the top line growth rate in the Australasian segment improves from the ~1% CAGR it has achieved since listing. There is some evidence to suggest this is already happening, with the annual growth rate improving year to year and investment into the expanding packaging solutions business likely to accelerate.

Going forward, ORA’s strategy will be regionally bifurcated, expanding aggressively in the US whilst further cultivating its existing asset base in Australasia. ORA is still integrating its POP operations into a cohesive division under the Orora Visual brand, but is building towards critical mass over the next 2-3 years through M&A, expansions of existing assets and possibly greenfield projects. In Australia, ORA will continue its onslaught on costs, having demonstrated an ability to materially raise margins over time. Through asset ‘refreshes’, management will improve utilisation, lower operating costs and improve energy and raw materials efficiency. ORA expects to have $150-200 million in annual cash flows available for reinvestment during the next ~5 years. We would expect around two thirds to be spent expanding Orora Visual and OPS with the remainder used to improve the fibre and paper, and beverage packaging divisions.

 


Figure 3. ORA shareholder value creation model (click image to enlarge)
Source: Company reports
 
Ultimately, ORA separates itself from its peers because it has both the cash flow and the pipeline to reinvest its capital at incrementally accretive rates of return. This is reflected in its ROE profile which, though still well below many of its peers, is improving over time without increasing leverage. Improving return metrics generated off of a conservative balance sheet and from a stable and predictable earnings base make ORA a highly attractive investment. Though ORA trades at a premium to its peers, this appears justified in our view and it currently trades slightly below our 12-month forward valuation of $3.07.
 

Figure 4. ROE breakdown via DuPont analysis
Source: Company reports, Clime estimates