Pact Packs In Acquisitions But Can More Be Done?

This story features PACT GROUP HOLDINGS LIMITED. For more info SHARE ANALYSIS: PGH

-Affirms acquisitions key to strategy
-Approved for large NSW acquisition
-Signals intent to bolster organic growth
 

By Eva Brocklehurst

The performance of packaging producer Pact Group ((PGH)) was lifted in the first half by the contributions from acquisitions, partly offset by subdued underlying conditions. In FY16 the company will benefit from almost a full year of contributions from the Sulo business as well as the post September 2015 contribution from Jalco. Jalco is expected to lower the overall group margin, notwithstanding the delivery of synergies.

The company's efficiency program is continuing to focus on the elimination of excess capacity to align with customer demand and this expected to deliver annualised savings of $15m in FY17.

The company has completed 44 acquisitions since listing and this remains a key part of its growth strategy. Management indicated its acquisition opportunities remain strong in both Australia and internationally.

Macquarie is particularly pleased this is still the case in core markets as greater synergies can be realised. The broker believes the company's diverse and defensive end markets underpin a substantial market position, with several levers at its disposal to deliver earnings growth.

UBS is concerned about the growth outlook when excluding the impact of recent transactions. Sales ex acquisitions are expected to be down 4-5% in FY16, which highlights the pressure from a loss of contracts and the weak outlook in some segments such as dairy. Jalco and Sulo are expected to underpin growth rates in FY16-18, which UBS expects to be around 4.0%.

Given the lower growth profile relative to its peers, UBS does not believe the stock warrants its current valuation metrics. A higher debt load, lower liquidity and greater execution risk are envisaged. Moreover, a single shareholder owns around 40% of issued capital and the broker believes this warrants a liquidity-related discount. Hence, UBS downgrades to Sell from Neutral.

Morgans also considers the stock fairly valued, while being attracted to the company's dominant market positions in Australasia as well as the high margins and the faster-growing rigid plastics market. Going forward the broker assumes earnings growth of 6.0% in FY17 and 5.0% in FY18, but acknowledges this depends on further acquisitions over the next few years.

The results were ahead of the market's expectations despite the challenging environment and Deutsche Bank concludes this has a positive bearing on the outlook. The company affirmed full year guidance for higher revenue and underlying earnings, subject to economic conditions. The broker reduces FY16 estimates by 2.0% but upgrades FY17 by 3.0% to reflect the net impact of higher earnings in Australia as well as operating efficiencies.

Packaging demand has been soft in agricultural and industrial markets globally, which is partly offset by stronger demand for materials handling. One development brokers also note is that the Australian Competition and Consumer Commission has stated it would not oppose the proposed acquisition of Power Plastics, a non-beverage rigid plastics business in NSW.

Credit Suisse had expected the company’s substantial market share in rigid plastics would preclude it from most domestic acquisitions. Power Plastics is the third largest rigid plastics business in NSW. The company may have reiterated its intention to continue acquiring businesses but the broker suspects there will be more emphasis placed on organic growth going forward.

The new CEO has signalled a change in corporate structure is being considered and the company openly discussed the erosion of organic growth. The broker found this development refreshing as it improves confidence in the company's ability to address the issue. Credit Suisse acknowledges organic top line growth has been a challenge and, if the company can combine growth with acquisitions and cost savings, it should underpin the share price.

The new CEO has indicated further cost savings which may be quantified over the next six months and the broker includes a second cost reduction program in its modelling, upgrading FY17-19 estimates by more than 2.0%. Looking into the second half, Credit Suisse also observes resin prices have fallen by a similar order of magnitude to the rise in the first half and an earnings benefit is expected.

FNArena's database shows two Buy ratings, two Hold and one Sell. The consensus target is $4.98, suggesting 2.8% upside to the last share price. Targets range from $4.30 (UBS) to $5.30 (Deutsche Bank). The dividend yield on FY16 estimates is 4.3% and on FY17 estimates 4.8%.
 

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