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Morningstar | Volatile Resin Prices Continue to Impact Narrow-Moat Pact Group in Early Fiscal 2019; FVE Unchanged. See Updated Analyst Note from 14 Nov 2018

Following three months of elevated oil price volatility, Pact Group has materially downgraded its fiscal 2019 EBITDA guidance to AUD 245 million from a prior range of AUD 270 million to AUD 285 million. Our fiscal 2019 EBIT forecast of AUD 173 million is now 8% above updated company guidance, reflecting our more optimistic outlook on resin prices and subsequently near-term margins. Furthermore, we remain confident previously announced cost-out initiatives will further support medium-term margin recovery. Following today’s aggressive share price sell-off, the market seems to be attributing little, if any, expectation of recovery in operating margins. As such, value has emerged in Pact shares that now trade at a 34% discount to our AUD 4.90 fair value estimate.

Resin prices have continued to trend unfavourably in early fiscal 2019. Contract pricing, which Pact resets on average every 90 days with its customers, has been unable to shield Pact’s margins from commodity market developments thus far in fiscal 2019. Updated management guidance assumes a continuation of the steep upward trend in resin prices experienced over the past three months throughout the remainder of the year. We remain comfortable with our view this is conservative, particularly in light of oil’s sharp retreat since early October, which will begin to provide earnings relief. With pricing mechanisms unchanged, we continue to view margin pressure from resin costs as a headwind that abates near term.

We continue, however, to highlight the importance of the previously announced AUD 50 million in cost savings to drive margins higher. The program announced in August, will rationalise the Australian rigids network and support our expectation of operating margins improving toward 11% in fiscal 2028, up from 8.7% in fiscal 2018.

While largely unchanged following Pact’s guidance downgrade, our fiscal 2019 EBIT forecast has been trimmed by AUD 5 million or 3.5%, reflecting the later-than-expected completion of the TIC Industries acquisition. Pact completed the acquisition effective Oct. 31, 2018, and we expect an EBIT contribution of AUD 11.6 million in the remaining eight months of fiscal 2019.