The North American division of Orora delivered the positive surprise element of the first half result. While many companies are struggling to pass on higher input costs, ORA is smashing it and there is room to improve the business further.
Group 1H22 EBIT of $154.5 million was 12% ahead of consensus expectations mainly due to a big performance from the North American division. Up there, EBIT of $70.5 million swamped the $58.1 million consensus target as sales increased 13.9% (local currency terms) and pricing was set to more commercial levels across approximately half the customer base leaving room for more.
The OPS team (Orora Packaging Services) has been gradually renegotiating or exiting unprofitable contracts so that earnings share from profitable customers is expanding. The inflationary environment has provided the OPS team with a greater opportunity to engage with customers. There have been 13 major price increases implemented in the last 18 months.
The small decline in Australasian EBIT to $84.0 million was due to weakness in the Glass category with volume down on reduced exports to China. The worst is behind the business with growth now in play.
ORA’s $120 million buyback is only about 20% complete and will continue to provide some share price support. Balance sheet leverage is currently at 1.6x EBITDA but is below the target range of 2.0-2.5x.
ORA continues to think about further acquisitions but has modified its approach. Lessons learned from buying small family/privately-owned businesses make that pathway less likely, but neither is there an appetite for buying big. The Goldilocks approach is needed where the target must have a strong value proposition such as pharma and medical applications where the packaging is critical but low cost relative to the end product. We anticipate some patience from ORA before the next move perhaps in FY23.
Investment view
The management outlook is for stable earnings in Australasia and growth in North America, repeating the 1H22 pattern. Guidance was slightly vague for FY22f EBIT to be higher than FY21.
We had previously thought North American EBIT margins would take some time to reach 5%, but this latest result arguably shortens those odds.
Risks to investment view
Earnings growth remains subject to global and domestic economic conditions, currency fluctuations and any further impacts from COVID-19.
Recommendation
We have upgraded our recommendation to Buy from Hold. This reflects the positive environment in the North American division and the potential for further acquisitions.
