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Pact Group still good value despite $320m loss, says Morningstar

Emma Rapaport  |  26 Feb 2019Text size  Decrease  Increase  |  
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Packaging manufacturer Pact Group reported a $320 million loss last week, which saw the share price plummet almost 10 per cent as investors baulked at the company's promise of cost savings. 

But Morningstar equity analyst Grant Slade says the market is too sceptical. In his eyes, it will recover sooner than anticipated, and is trading at a 40 per cent discount.

At 4.30pm on Monday, Pact Group (ASX: PGH) was down 1.75 per cent, trading at $2.81.
Slade reached his 40 per cent discount after conducting a revised evaluation following the company’s first-half result last Wednesday.

Pact Group First Half Result

Higher raw material costs and energy bills hurt Pact Group's earnings

Slade has lowered his fair value estimate by 14 per cent to $4.20 per share on account of reduced earnings estimates and an equity raise that he says will likely proceed at a price below fair value.

Pact, which carries a narrow moat rating, reported net profits after tax but before significant items of $36 million, down 29 per cent on the prior corresponding period.

It also posted a loss of $320 million after $44 million in profits in the same half last year.

The company said the increased cost of raw materials and ongoing higher energy costs and hurt earnings.

Other factors also weighed on the company: a loss in sales volumes, linked to drought, availability of materials handling projects and weak demand in the dairy, food and beverage sector.

Soft Australian trading conditions and heightened capital requirements led Pact to suspend its dividend in first-half fiscal 2019, which now makes an equity raising now look imminent.

Slade said the result tracked broadly in line with expectations given the first-half earnings before interest tax depreciation and amortisation of $110 million was pre-announced.

He said the increased cost of raw materials had come at a bad time for the company as it had taken on several projects.

He fears that volumes from dairy, food, and beverage customers were also lost, and has lowered Morningstar's top-line forecast for this segment, reducing earnings before interest tax projection by 15 per cent to $89 million.

However, this weakness was offset by a better performance in the materials handling and pooling segment.

Pact confirmed timing for its cost-out program, with the remaining $40 million in savings to be delivered by end of fiscal 2022, alongside program capital expenditures of $175 million.

Pact founder Geminder to the rescue

Slade is confident Pact founder and acting executive chairman Raphael Geminder, who has an approximate 40 per cent stake in the company, will lead the business to success.

Geminder took over from chief executive Malcom Bundy who made a surprise exit from the company in September last year.

"Given the situation the company now finds itself in, where margin repair is imperative, I believe Geminder will focus on finding someone who understands plastics and packaging operations rather than broad management process," he said.

"Geminder, as the founder of Pact and formerly of Visy Industries, is well placed to run the company in the interim."

This should help reassure shareholders who have fallen out of favour with Pact since it badly missed earnings guidance in August 2018 and has posted two downgrades to fiscal-2019 guidance in the last six months.

This, Slade says, has created a credibility issue for management, with the market pre-judging the success of their promised cost-cutting program.

Slade, however, retains his belief in management’s ability to succeed and is encouraged that the cost-cutting plans are realistic.

He says the fact the majority of the costs savings will come from identified duplication means management will have a good line of sight as to what they can deliver.

Ahead, the company has been awarded a long-term contract to provide returnable produce crate (RPC) pooling services to ALDI, the No 3 player in the Australian supermarket industry, for its fresh produce supply chain.

Slade says the deal will leverage Pact’s existing crate-washing facilities, and management expects the contract to hit Pact’s internal return targets in its first year of operation.

While Pact failed to provide forecast revenue or margins, Slade expects the deal to deliver $27 million in by fiscal 2021.

is an editor for Morningstar.com.au

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