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Morningstar | Market Expectations Are a Tall Order for No-Moat Orora; Decreasing FVE by 13%

With mature and in some cases declining packaging categories in its Australasia segment, the market sees big things for no-moat Orora in its North American distribution business, given its current share price. While acquisitions will be a focus for the company in the U.S. to achieve greater scale in distribution, we question whether this can be done in a value-accretive manner. Following a change in analyst, we decrease our fair value estimate by 13% to AUD 2.40 per share. With Orora trading at 1.4 times our fair value estimate, expectations for accretive merger and acquisition activity in North America are lofty at best, and we see shares as significantly overvalued.

The decrease in our fair value estimate reflects lower expectations for top-line growth over our 10-year forecast period, with a revenue CAGR of 2.8%, revised from 4.4%. Lower volume expectations drive the top-line downgrade. We expect corrugated box volumes to grow at an average of 1.2% over the coming decade, with Orora playing in a more niche, slightly higher-value segment than Visy, making gains in share difficult to come by. Beverage volumes, in contrast, have been revised lower to reflect the trend toward lower carbonated soft drink, or CSD, and alcohol consumption. We now expect flat volumes in glass packaging, while volumes in aluminium cans should retreat at an average of 0.5% annually over the coming decade with declining volumes in CSD and beer and with alternative applications for these packaging substrates limited. Revised volume expectations are therefore less optimistic than our prior forecast for roughly 1.25% volume growth across the entire Australasia portfolio. We also revise our volume expectations for the North America distribution business, now expecting volume growth to average 0.3% per year over the coming decade, down from a prior 1.25%.

Orora’s operational focus on its Australasian fibre operations has seen material improvement in group EBIT margins to 7.6% in fiscal 2018, up from 4.6% following the demerger in fiscal 2014. However, we expect margins to remain flat over the coming decade, as improvements from fibre conversion upgrades, rationalisation, and gains in operating leverage at the containerboard mill have now been largely realised.

While increased e-commerce sales will provide a tailwind to the containerboard industry in both Australia and the U.S., developed economies overall are becoming less containerboard-intensive. Volume growth in U.S. containerboard consumption has trailed economic growth by around 0.6% annually over the prior five years, as economic output continues to skew towards services while the proportional contribution from agricultural and industrial sectors to GDP continues to diminish. In Australia, the downward trend has been even starker, with containerboard volumes flat and thus trailing economic growth by 3.3% annually. We expect this trend to continue in both of Orora’s markets, in spite of the partial offset provided by increased e-commerce sales.

Orora has announced the acquisition of Texas-based packaging distributor Bronco Packaging Corp. for USD 24 million. With the business generating USD 50 million in annual revenue, the transaction is immaterial but forms part of the larger strategy to markedly increase scale in North American distribution. As such, we can expect a marked increase in similar transactions to occur in the U.S.