In early September, Orora (ASX:ORA) completed a sizeable equity raising at $2.70 per share. Since resuming trading, the shares have either traded around, or below, the offer price. Whilst recent equity market conditions have been a contributing factor, market concerns about the Saverglass acquisitions have also weighed on investor sentiment.
Since our research report on the Company in The Dynamic Investor in early October, the share price has continued to weaken. Accordingly, we assess whether current levels present a more attractive entry point.
Orora’s core businesses include the design and manufacture of packaging products such as glass bottles, beverage cans, corrugated boxes and recycled paper in Australasia. The Company also has three operating segments in North America.
Both the Australasian Beverages and North America packaging solutions & visual businesses are positioned in the top five of their respective market segments. The Company currently reports results across two divisions: North America and Australasia, with the North America division accounting for 76% of group revenue and 52% of group EBIT in FY23, respectively.
On 5 September 2023, ORA announced an agreement to acquire 100% of Saverglass SAS (‘Saverglass’) for €1.29b (A$2.16b). Saverglass will fit into the Orora group as a third growth platform to supplement existing operations. Completion of the acquisition is expected at the end of December 2023.
Key Fundamental Drivers
Sound Strategic Rationale for Saverglass Acquisition
ORA’s acquisition of Saverglass will see it operate further up the packaging value chain and move into the higher ‘product-to-pack’ segment. A key attraction of the acquisition is that Saverglass is not a capital-intensive business.
According to ORA, premium spirits and wine categories have a favourable growth outlook and improved margins. This is due to the shift towards premium products, as well as greater depth of design, quality and brand importance in luxury spirits/premium wine bottles.
The return on investment is expected to generate an attractive premium to the Weighted Average Cost of Capital (WACC). ORA has previously highlighted a 15% Return on Average Funds Employed (RoAFE) target for organic growth investments.
Notwithstanding the relatively low level of expected cost synergies, there is scope for harder-to-quantify benefits such as scale, revenue synergies and diversification benefits for Orora and customers.
Mixed Performance for Existing Operations
ORA’s results for FY23 demonstrated mixed EBIT margin performance across its two core divisions. EBIT margin for the North America business increased by 90 basis points to 5%, driven by price and optimization gains. This improvement was achieved despite challenging US macroeconomic conditions. In contrast, EBIT margin for the Australasia business fell 178 basis points to 15%. This reflected margin dilution from higher aluminium costs.
i. Further incremental improvement in EBIT margin for the North America segment is expected, from three avenues: Further benefits from the optimisation program flow through,
ii. Product mix is expected to continue improving as ORA target higher-value customers and
iii. ORA is targeting more specialised products.
For the Australasia division, ORA expects to see growth in cans driven by volume growth and product mix optimisation. However, this is likely to be offset by softness in consumer demand for Australian wine.
High Level of Gearing is Concerning
ORA’s expects its gearing post-acquisition to be 2.5x, which is at the upper end of the Company’s 2.0-2.5x target range.
ORA ended FY23 with a gearing position of 2.0x (on a net debt to underlying FY23 EBITDA basis). Except for the FY19 period, where the gearing level was elevated because of acquisitions, heightened capital investment and a build-up of working capital, gearing has typically remained below the Company target of 2.0-2.5x.
Following the Saverglass acquisition, gearing (on a proforma basis) is expected to be 2.5x. the gearing level is expected to remain elevated (and above the upper end of the target range), given that:
i. ORA’s free cashflow over the next few years will likely be hampered by a step-up in working capital and CAPEX.
ii. Aside from the rebuild, the Company will undertake a number of growth/expansion projects in the Australasian business.
iii. The earnings contribution from Saverglass is not expected to be material until FY25.
We still consider investment risk in ORA is elevated. This is due to the large size of the Saverglass acquisition, which represented >70% of ORA’s market capitalisation prior to the deal announcement. In addition, management has a limited track record in integrating a deal of this nature. To this end, ORA is unlikely to earn a re-rating until it can demonstrate that the integration of the Saverglass acquisition results in improved financial metrics.
ORA was trending well in the first part of this year until it saw a large amount of price rejection in August. Then, in early September, it dropped sharply and found support back near the January/February lows. It then tried to hold in to build a base but a break of support near $2.65 is now seeing it start trending lower. For the moment it is best to avoid and investors can aim to pick it up at cheaper levels.
Michael Gable is managing director of Fairmont Equities.
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