Monday, 9 June 2014

Orora, a spin-off from Down Under

Orora is an Australian listed packaging business that presents an interesting spin-off opportunity. It used to be part of a large Australian packaging company named Amcor, however in order to focus the business it decided to split the business into two (1) remaining of Amcor to focus on specialty packaging (healthcare, personal care, F&B etc) and (2) Orora on fibre, beverage packaging in Australasia and packaging distribution in North America. All figures below in A$.

While admittedly packaging isn’t the most exciting business in the world (no offence meant to anyone), Orora could be a textbook spin-off case. Amcor is a much larger company with market cap of $13bn while Orora with $1.7bn, currently. Thus when investors received shares in Orora (1:1 distribution) Orora’s share price didn’t exactly tank but definitely saw sharp selling. Now the share price is up around 20% since the low point to $1.4 where it has been flat for the better part of last three months. Orora has a couple of things going for it, namely an on-going restructuring and capable management team.

As a quick detour, in the last three years Orora generated revenues of $2.9bn on average and EBIT of $150m across its two segments. The bear share of this is from the Australasia business, which produces corrugated packaging (think cartons, boxes, recycled paper and so on) and packaging for beverages (cans, glass bottles etc). In each of these segments it has significant scale and either no. 1 or 2 in the AUS/NZ markets, which is key in capex intensive, low-ish margin businesses. The second segment is Packaging and Distribution based in the US and engaged in distributing packaging materials and shipping/logistics services to clients, operating under the Landsberg and MPP/CK brands.

Now back to the story around Orora. Prior to the spin-off Amcor was busy restructuring the business and moving away from lower margin businesses, resulting in closures/divestment and reorganisation of Orora’s manufacturing facilities and operations in its home turf along with bolt-on acquisitions to gain scale and improve margins. Management noted that they are continuing to reorganise the business and identified around $95m cost cutting opportunities over the next few years. In fact, $12m has been achieved in 2013 and $16m in H1’14 (of $30-40m budgeted) with about $20m related capex to be spent over 2014/15. Now it’s unlikely that all of the c. $95m goes to profitability, as they’ll probably share some of the upside with customers, offset cost inflation etc. In any case, this programme will lead to meaningful increase to profitability.

Orora isn’t exactly what you’d call a high-growth business; in fact it’s a mature and defensive. Prior to the spin-off, management initiated a fairly aggressive dividend policy with a 60-70% payout ratio. Delivering on the restructuring is key if one were to see meaningful increase in dividends and value. In H1’14 ORA earned $52m after tax and management declared $0.03 per share dividend (around $36m or 70% payout) or 4.3% annualised yield based on current price.

Orora is left with $65m of benefits to be achieved over 2 years or so (considering that what has been achieved YTD H1’14 is probably priced in). Assuming that only 80-90% of this stays with them (some goes to share with customers, cost increase etc) we have about $35-40m post-tax net benefit, which assuming a 65% payout could add around $2c to the dividend. Assuming a 4% yield (based on current but further compressed) this could add $0.5-0.6 to the share price taking it closer to $2 for a c. 35-40% upside from current. Now of course this is over 2 years or so. The above assumes steady state i.e. no growth in the businesses and a defensive view on the restructuring. Additionally, as capex subsides management could use excess cash to buy back stock or pay down debt (which for now is fairly high at around 3x EBITDA on a net basis).

What makes me a bit more comfortable about this restructuring is Orora’s management. Prior to joining Amcor in 2009, the CEO spent 8 years at SPC Ardmona (packaged food business in Australia). He reorganised and grew the business via M&A and eventually sold it to Coca Cola Amatil (Australian beverage co) in 2005 after three-way deal talks. In addition, him and the chairman have been buying shares in the open market recently, which can be seen as a positive step.

To sum, Orora presents a possibly rewarding spin-off opportunity in a defensive business with the on-going restructuring serving as a catalyst executed by a capable management team, who have skin in the game.