Orora Awaiting The End Of Destocking

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Global packaging business Orora continues to struggle in the near term, but brokers agree the company’s prospects in the longer term do look promising.

-Orora reiterates downgraded guidance
-Analysts invited to tour Saverglass facilities
-Destocking continues, but Saverglass customers are sticky
-Innovation will drive future earnings

By Greg Peel

In late 2013, global packaging giant Amcor ((AMC)) spun off its Australasian packaging business into the separately listed Orora ((ORA)), leaving Amcor to focus on making flexible- and rigid-plastic packaging and tobacco packaging, mostly for overseas markets.

Orora has since become a (smaller-sized) global company in its own right, expanding into North America and Europe.

It’s been a bumpy road for Orora, trading just under $4 five years ago, the share price fell to around $3.35 by September last year and is currently trading at $2.18. That recent de-rating was sparked by the company's acquisition of French-based glass packaging manufacturer Saverglass, which services customers globally with a history going back beyond a century.

The issue for Saverglass has been one of customer destocking. This has been exacerbated by packaging price deflation in North America, and led Orora to downgrade earnings guidance earlier this month. Amcor has suffered similar issues post-covid, and has also seen its share price creep lower.

But confident in the longer term prospects for Saverglass, Orora last week took analysts to France for a tour of the Saverglass facilities, and provided an update on current trading conditions.

The Future Looks Bright

…perhaps in the longer term, but not so much in the here and now.

In France, management reiterated guidance provided earlier, expecting Saverglass volumes to be down -11% in the second half FY24, consistent with the first half.

Underlying consumer demand remains mixed with customer destocking continuing. Importantly, suggests Goldman Sachs, visibility into the end of the destocking cycle is limited, even with emerging signs of positive depletions in key markets like the US, which accounts for roughly 50% of end-market sale.

To the extent that Orora warehouses sold customer inventory, management stated stock levels continue to normalise. Yet the prevailing uncertainty was reflected in the group’s recent order profile. Specifically, management stated the February order book had strengthened but a number of orders were subsequently pulled or delayed.

Saverglass has seen no indications of improvements in demand or ordering and the North American Orora Packaging Services (OPS) business saw no volume improvement from February into March despite the period normally benefitting form a pre-summer seasonal uplift in consumption.

Despite weak expectations already, Jarden sees further downside risk to the FY25 outlook if improvements in demand are not forthcoming in the months ahead.

Strategically, the OPS business is focused on growing its Mexican presence, investing in its sales team to more than double the sales rep count. This aligns with the objective to invest in the OPS sales force more generally, with Orora focused on continuing to expand its earnings margins.

OPS is accelerating cost actions in response to the current environment and absence of a seasonal uplift via management of suppliers and operating cost discipline to right-size costs.

Innovation

In the longer term, Orora is confident in its product innovation, and the stickiness of its customers. Management highlighted the complexities of developing a new product for a customer, which makes customers much stickier than may be the case for more commoditised packaging products. This means softer volumes obviously impact the business but don't see the double impact of meaningful price competition or customer switching, Morgan Stanley notes.

It also means Orora is protected by barriers to entry.

Management continued to express confidence in category premiumisation and that its network and design capability is well suited to capitalise on this trend. For instance, notes Goldman Sachs, Orora showcased its acid etching machine that was internally designed and allows a frosted look in a continuous manufacturing process.

In terms of ongoing innovation, Orora demonstrated its “decoration configurator” that allows customers to virtually iterate designs, and other digital platforms that allow Saverglass to optimise mould performance in a simulated machine environment. These types of initiatives allow the business to improve efficiency while maintaining a premium design that is a key part of the customer’s brand identity.

Goldman Sachs believes the business should also benefit from customer product innovation, with a pipeline in place of over 190 new product launches versus a “normal” 150. Saverglass’ catalogue business is particularly well suited for any potential customer product innovation, the broker suggests, and more broadly for customers that would not otherwise have scale to order bespoke designs needed at premium price points, such as premium craft distillers.

Downunder

Orora’s A&NZ can business is well positioned with 60% market share in relatively strong growth categories that benefit from substrate shift, Goldman notes, complemented by growth of multi-size formats. Management stated the capital investment program in the business remains on time and on budget with a target return in excess of 15%.

The glass business continues to face weak demand for Australian commercial wine, with the benefit from China wine exports anticipated from FY25.

Management is expecting 85-95% of total volumes across FY24-28 will be under contract, giving solid revenue security medium term. The Revesby (Sydney) can line is on track for commissioning in the March quarter FY25, and will deliver a greater than 10% increase in capacity.

Show Me the Money

An end to destocking and demand softness remains elusive, and these conditions have persisted longer than management anticipated. Management expressed a view that December half volumes should improve, albeit this is based more on opinion than data and Morgan Stanley expects the market will wait for empirical evidence before being convinced.

The broker does believe softness has been cyclical rather than structural but, again, evidence will be required to see these proven out.

The investment thesis has clearly been more difficult than contemplated, Morgan Stanley admits, when it moved to an Overweight stance in November. That said, this broker believes Saverglass will prove to be a quality asset. An end to destocking and a resumption of cyclical growth remains the key catalyst.

Morgan Stanley has a $2.90 price target.

Looking beyond FY24, UBS thinks investors are focused on the potential for Saverglass to add a third growth platform to Orora's existing A&NZ beverage and North American distribution units, however, at this point the broker retains Neutral on valuation, noting the company's leverage guidance is elevated and increasingly in focus given the uncertain earnings growth outlook.

UBS has a $2.56 target.

Given investor concerns about leverage, Orora mentioned capex into Mexican expansions and repair of furnaces can be delayed from FY25 to better protect the cash profile of the business during a period of subdued volumes. The company is set to focus near term on delivering cash flow and earnings improvement, which would provide additional support to the balance sheet. Jarden models a dividend payout ratio of 64% for FY24, within the target range of 60-80%.

Jarden is Overweight with a $2.50 target.

Goldman Sachs has a Buy rating and $3.00 target.

Yesterday, Orora shares closed at $2.18.

Not choosing to update on the trip to France, to date (or maybe they weren’t invited), Macquarie had an Outperform rating post the April guidance downgrade with a $2.75 target, while Citi had Buy and $2.86.

Morgans was on Hold with $2.30.

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