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Morningstar | Oil Price Rout Reduces Near-Term Revenue for Plastic Packaging Names But Valuations Unaffected

Concerns of oversupply in oil markets have markedly sent down oil futures and our near-term oil price forecast in recent months. Lower resin costs for narrow-moat Amcor and narrow-moat Pact Group are therefore anticipated over the coming five years. However, contractual arrangements with customers, where resin price volatility is passed-through, means that revenue will also contract over the same period. While we revise our near-term top-line forecasts lower for Amcor and Pact Group, earnings and valuations are largely unaffected by resin price volatility. We reiterate our fair value estimates for Amcor and Pact Group at AUD 14.60 per share and AUD 4.90 per share, respectively. While value has emerged in both names following recent share price weakness, we continue to prefer Pact Group which trades with margin of safety at 0.68 times fair value.

The recent rout in oil prices has wiped almost 40% off oil benchmarks in the last three months--Brent crude closed at USD 56 a barrel on Jan. 3, down from its recent high of USD 86.29 a barrel in early October. Resin prices, while not perfectly correlated, tend to move in unison with oil prices and we are seeing resin futures also track lower as a result of this relationship. The retracement in resin costs bodes well for Pact and Amcor in fiscal 2019, with the first quarter of fiscal 2019 having been characterised by a continued surge in oil prices. While contract repricing is generally protective of margins, lags in the resetting of contract pricing means that near-term margins can be crimped by sharply appreciating resin prices. While revenue has been reduced by 5%-7% for both names over the fiscal 2020-2021 period, earnings growth is unaffected. In the case of Amcor, we continue to expect a 10-year operating income CAGR of approximately 3.5%. Meanwhile, we expect Pact Group’s operating income to grow at a 10-year CAGR of approximately 7%, also unchanged.

Valuations are also unaffected by the recent downgrade to global growth expectations. The IMF’s calendar year 2019 global growth forecast was downgraded, in October 2018, by 0.2% to 3.7%. While the global expansion is set to continue in their view, the IMF believes we are now nearing cyclical peaks in major economies including the U.S. and the euro area. In emerging markets, China and a number of Asian economies featured in the IMF’s downgrade to global output. At the same time, the IMF asserts that risks to global growth now skew to the downside, highlighting rising trade barriers and a reversal of capital flows to emerging markets, or EMs.

This translates to lower growth in income per capita over the coming the forecast period. But the impact to forecast volumes is immaterial given the defensive nature of plastic packaging demand which is largely tied to consumption of defensive food, beverage, and household categories. Amcor and Pact’s top lines are therefore largely unaffected. In developed markets, Western Europe volumes are most impacted by the downgrade and we now forecast a 10-year volume CAGR of 0.6% in Western Europe, down from 0.7%. Forecasts for North American and Australasian volumes are unchanged, however, and we continue to expect 10-year volume CAGRs of 1.0% and 1.3%, respectively.

Volumes in EMs will be more impacted by the global growth downgrade, with the IMF expecting EMs to slow to a greater extent than their developed counterparts. We now expect volumes in Asia and Latin America to expand at a 10-year CAGR of 3.4% and 1.6% respectively, with the downgrade shaving 0.2% from volume growth forecasts in both geographies. But with Amcor and Pact deriving approximately 70% and 95% of sales, respectively, from developed markets which are less impacted by the downgrade, lower EM volumes have a negligible effect on our top-line forecasts.