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Packaging and pallets: 2 defensive picks

Glenn Freeman  |  16 Apr 2020Text size  Decrease  Increase  |  
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Plastic packager Amcor and pallet-maker Brambles benefit from their reliance on household consumption versus the lockdown-exposed business sector.

Amcor (ASX: AMC)

Morningstar Rating: 4-star | Economic Moat: Narrow | Price-to-Fair Value: 0.9

Amcor is trading at a discount of around 8 per cent to Morningstar's fair value estimate, and is defensively positioned amid the current volatility.

The company makes plastic packaging used for many household food items including dairy products cheese, fruit and vegetables and pet food. It also manufactures rigid plastic containers for retailers of food and beverages, personal care items and pharmaceuticals.

"Amcor's plastic packaging volumes are tied intimately to the consumption of household staples, meaning its volumes will soften only marginally," says Morningstar equity analyst Grant Slade.

He's slightly reduced his projected earnings over the next two financial years to reflect this slight fall in volumes, but his long-term outlook remains positive.

To make its plastic products Amcor relies on resin. The company's size and global reach—with a market cap of $13.4 million and businesses Europe, Asia-Pacific, Latin America and North America—give it a strong price advantage over smaller companies in the segment.

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Slade says these resin procurement advantages are both sustainable and have a material positive effect on the overall business.

"Particularly in light of the mature nature of markets that the plastics industry sells into, where demand is derived from household consumption."

Company debt levels—or leverage—are one of the key measures of company sustainability for investors to consider in the current market climate. Amcor currently has net debt-to-EBITDA of 2.9-times. This sits slightly above the sweet spot of 2.75-times management prefers and is due to Amcor's acquisition of North American competitor Bemis in June 2019.
But Slade says this leverage will recede in the medium term to a range within the comfort levels of the major credit-rating agencies.

"Standard & Poor's and Moody's could both downgrade Amcor one further notch, and its debt would still retain a desired investment-grade designation."

Slade also sees little risk of capital raising initiatives—which reduce share prices for existing investors—amid the current economic fallout.

"Amcor has ample liquidity to navigate any ensuing period where credit markets become icy and the refinancing of debt problematic.

"We view Amcor’s liquidity as sufficient to ride out the storm unscathed. Furthermore, Amcor’s balance sheet retains significant headroom above internal leverage targets."

brambles vs amcor

Brambles (ASX: BXB)

Morningstar Rating: 3-star| Economic Moat: Wide | Price-to-Fair Value: 0.93

While at a smaller discount to fair value, pallet-maker Brambles also holds appeal for many of the same reasons as its industrials sector peer Amcor.

Brambles is the world’s largest pallet and container pooling provider, operating in 60 countries throughout the Americas, Europe and Asia-Pacific under its CHEP brand.
Morningstar's Slade has left his fair value estimate at $12.00 a share unchanged, despite the sell-off that saw Brambles stock price drop from $13.14 to $10.34 between the middle of February and March.

"We view the sell-off of Brambles’ shares amid the COVID-19 equity market rout as overdone," he says.

Brambles also holds a strong balance sheet, which is "unquestionable" even in the uncertain environment of recent months.

"Leverage also remains conservative with substantial headroom to debt covenants," Slade says. These covenants are negotiated lending arrangements with banks or other financiers.

"With confidence that Brambles has the ability to fund its operations through the medium term, we view Brambles’ present share price—having last traded at an approximate 5 per cent discount to our unchanged fair value estimate for the wide-moat name—as modestly undervalued."

Slade sees little negative impact to Brambles' dominant pallet pooling business in North America and Europe—which comprise some 85 per cent of group revenue—from coronavirus.
But he expects earnings will be under pressure between fiscal 2021 and 2022 where organic growth—through natural business growth rather than acquisition—is tipped to slow.

"We now forecast a 7 per cent contraction in EBIT in fiscal 2021 to US$769 million, but we expect a swift, strong rebound in fiscal 2023 as the global economy recovers," Slade says.

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is senior editor for Morningstar Australia

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