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Morningstar | Acquisitions Paper Over Weak North American Volumes for Orora; FVE Unchanged

Organic growth stalled in no-moat Orora’s North American businesses in first-half fiscal 2019. Tough U.S. trading conditions cited by management are concerning and contrast starkly with generally supportive macroeconomic conditions and still rising U.S. corporate profits. However, Orora’s Australasian segment delivered a good result off volume and margin gains. While we’ve trimmed our full-year expectations for North America, our full-year fiscal 2019 EBIT forecast is largely unchanged at AUD 360 million. We maintain our fair value estimate of AUD 2.50 per share. Orora continues to screen as expensive, trading at a circa 30% premium to our valuation.

The Australasian result was solid with volumes and margins looking strong. We estimate volumes grew 1.8%, delivering first-half sales of AUD 1,088 million. This compares favourably with our unchanged expectations for volume growth of 1.2% in fiscal 2019. Segment operating margins of 11.7% also strengthened 0.1% from operating leverage at Orora’s B9 paper mill. B9’s production levels are on track to hit full capacity as in fiscal 2018. We continue to forecast a full-year segment operating margin of 11.0%, in line with fiscal 2018, and unchanged segment EBIT of AUD 240 million.

Anaemic first-half organic growth in North America leads us to trim our full-year expectations. We estimate that organic revenue grew just 2.5% to USD 844 million. But volumes stalled, with organic top line growth derived largely from the pass-through of increased wholesale paper and resin prices to customers. Acquisitions meanwhile delivered around USD 38 million in incremental sales. With conditions likely to persist into the second half, we now expect flat organic volumes in North America in fiscal 2019, revised from 3.3% growth. While a first-half segment EBIT margin of 5.3% was 0.4% lower, it largely tracks our full-year forecast. We now expect segment EBIT of AUD 137 million, 2% below our prior forecast.

Combined consideration for the Pollock and Bronco packaging distribution businesses in the U.S. totaled AUD 142 million and saw the balance sheet more leveraged at the half year-end. Net debt/EBITDA increased to 1.95 times from 1.5 times at fiscal 2018 year-end. However, we expect net debt/EBITDA of 1.6 times at fiscal 2019 year-end with both businesses contributing to a greater extent to EBITDA, with Pollock only contributing one month’s earnings in the first half. Therefore, considerable balance sheet flexibility remains for Orora, with management continuing to assert their strong preference for North American acquisitions as opposed to capital management options.