Brokers Welcome Pact’s Expansion Into Pharma Packaging

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Packaging producer Pact Group is expanding, moving into the manufacture of tablets and capsules with the acquisition of Australian Pharmaceutical Manufacturers.

-Advances Pact's co-manufacturing operations and complements Jalco acquisition
-Pharma/neutraceuticals end market considered one of the few positive areas of growth
-De-stocking in the vitamin segment could continue for remainder of 2016
 

By Eva Brocklehurst

Packaging producer Pact Group ((PGH)) continues with its strategy of expanding in adjacent categories of contract manufacturing, with its latest acquisition being Australian Pharmaceutical Manufacturers (APM) for $90m.

Brokers welcome the transaction, as the APM business is one of the largest providers of packaging solutions for nutraceuticals in Australia and specialises in manufacturing and packaging tablets, hard gel capsules and powders. Facilities are located in Keysborough, Victoria.

The price is reasonable, the transaction accretive and should generate a pre-tax return on capital in excess of the company's hurdle rate of 20% by year three, Deutsche Bank calculates. The business complements the existing co-manufacturing operations of Pact's Jalco business. The acquisition will be funded via $75m in bank debt and a $15m share issue.

The transaction furthers Pact Group's advance into co-manufacturing, Macquarie agrees, extending the position established with last year's acquisition of Jalco. Jalco was considered a beachhead in the contract filling market and, while Macquarie expected further acquisitions, this particular one now takes Pact into the pharmaceutical area. The broker also notes it is positive for margin mix.

The company has stated that there is a significant overlap in customer portfolios and Macquarie understands Blackmores ((BKL)) is a customer of both Jalco and APM. Health and personal care accounted for 12% of Pact's revenue in 2016 and the pharmaceutical/neutraceutical end market is considered one of the few positive areas of growth.

CLSA believes this acquisition, in conjunction with stable, but not stellar, organic growth, should ensure Pact Group sustains double digit earnings growth. The stock is attractive to the broker, trading at a discount to both market multiples and its peers.

One area of concern in the near term is the fact that the vitamin segment is experiencing an inventory build up and de-stocking could persist through the rest of this year. While this may negatively affect near term earnings, CLSA is confident that the risk is captured in the price and the medium-term demand outlook remains strong. The broker, not one of the eight monitored daily on the FNArena database, has a Buy rating with a $7.75 target.

Customer volume is underpinned by a surge in demand for vitamins and supplements from Chinese consumers and APM supplies some large and successful brands such as Swisse, Credit Suisse notes. While capacity in the tablet industry had expanded to meet demand from China, more recently that demand has slowed as excess inventory carried by retailers and distributors in Australia affects brand sales. Credit Suisse suspects that upstream manufacturers such as APM could soon be affected by this build up, although the headwinds are expected to be short term.

On the subject of Pact's capacity for further acquisitions, the broker also believes the company's ability to fund these through debt is nearing its limit for FY17. The ratio of net debt to EBITDA is around 3.0 and management has previously stated the comfortable upper end is around 2.8-3.2. Hence, the broker anticipates high gearing may constrain further acquisition upside.

Morgans is attracted to Pact's dominant position in its markets in Australasia, and the high margins, with exposure to the faster-growing rigid plastics market. The broker calculates the acquisition will be accretive by 3% in FY17 and 5% in FY18.

Morgans believes the trend towards greater emphasis on health and well being means there is solid growth potential in the acquisition and the deal will also diversify Pact's revenue base away from food, dairy and beverages. Nevertheless, the broker believes the stock is fairly valued and retains a Hold rating, given the limited organic growth and overall upside largely driven by acquisitions.

The database shows two Buy, two Hold and one Sell (UBS, yet to comment on the acquisition) for Pact. The consensus target is $6.34, signalling 2.3% in downside to the last share price. Targets range from $5.60 (UBS) to $6.80 (Deutsche Bank).
 

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