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Pact's new chief is full bottle on strategy, innovation, says Morningstar

Lex Hall  |  29 Mar 2019Text size  Decrease  Increase  |  
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Pact Group's decision to appoint BlueScope's Sanjay Dayal as chief executive will help lead the specialist packaging company’s turnaround and boost its technical clout, says Morningstar.

The market seems to have welcomed the news of Dayal’s appointment, which was announced last Thursday after the surprise exit of CEO Malcolm Bundey late last year. Pact Group (ASX: PGH) was up more than 1 per cent at $2.79 at 1.15pm Sydney time.

Pact is trading at a 33 per cent discount to the unchanged $4.20 fair value estimate set by Morningstar analyst Grant Slade, who has applauded the appointment of Dayal.

Dayal has a strong background in the chemicals industry, and currently serves as BlueScope Steel’s offshore building products businesses in Asia-Pacific and North America.

“Pact is set to benefit from Dayal’s strong technical credentials, expertise in both corporate innovation strategy and experience in business turnaround,” says Slade in note published on Friday.

“Importantly, his technical grounding should see him well equipped to lead the vital rationalisation of the Australasian manufacturing footprint, which offers a path to margin recovery.”

Pact and Visy dwarf rivals

Pact is the largest rigid plastics player in Australia and New Zealand, with an estimated market share of 35 per cent of the Australian rigids market. Its market cap is $922 million.

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Pact’s largest shareholder and group executive chairman is Raphael Geminder, who is closely associated with the other big packaging player, the privately held Visy.

Visy is the market leader in PET carbonate beverage manufacturers but also a player in food, beverage, and dairy rigids, with an estimated share of 35 per cent.

Pact and Visy dwarf the next level down of rivals, with about 20 companies accounting for the remaining 30 per cent of Australian market share.

Pro-Pac (ASX: PPG), the only other ASX-listed plastics peer, has a market cap of $114 million and generates about $75 million in revenue.

In contrast, Pact's market cap is $949 million and its fiscal 2017 Australian revenue topped $1 billion.

Risks and competition

The appointment of Dayal last Thursday comes at a crucial time for Pact, which has endured rising prices of energy and raw materials, and weaker customer demand.

Its share price hit a record low last month after the company revealed its profits fell more than 800 per cent because of a non-cash impairment of $327 million.

And Geminder was forced to take over the day-to-day running of the business as executive chairman after former chief executive Bundey suddenly stood in September last year.

Morningstar’s Slade concedes the sudden exit is cause for concern as Bundey had played a key role in Pact’s acquisition of assets from global packaging business Reynolds Group Holdings.

Nor is Slade jubilant about Pact’s push into Asia, where he fears the competition will be intense and could hurt the company’s margins.

In February last year, Pact acquired beverage closures and rigid bottle manufacturing assets from global packaging business Reynolds Group Holdings at 6.8 times EBITDA before synergies.

“With EBIT margins of 8.3 per cent in generic categories and competitive market conditions, we see risk skewed to the downside for margins,” Slade says.

Among other points of uncertainty, Slade is wary of the potential for market share loss if Pact’s predominantly large customers seek out alternative suppliers.

This risk is highlighted by fall in segment margins to 8.9 per cent in fiscal 2017 from 11.5 per cent in 2013, Slade notes.

Similarly, oil price volatility can affect near-term margins. 

Key local acquisitions, edge in costs

However, Slade says there are reasons to be upbeat.

"Pact has begun to diversify both geographically and into adjacent activities, and recent acquisitions have pushed the contribution of revenue from contract manufacturing to 20 per cent," he says.

"These businesses supply the non-food fast-moving consumer goods, including health and wellness segments." 

Pact has also acquired a crate-pooling service in New Zealand and established a plastic crate-pooling business here, Viscount Pooling Systems, which supports the fresh produce supply chain of Woolworth’s, Australia’s biggest supermarket chain.

Viscount has also secured a long-term contract to provide crate-pooling services to Aldi, the third largest supermarket chain in Australia.

“We expect Pact’s returns on invested capital to remain comfortably ahead of the weighted average cost of capital for at least the next 10 years owing to Pact’s sustainable cost advantage,” Slade says.

“In all, well ROICs averaging 9.3 per cent over fiscal 2019 to 2028.”

Pact carries a Morningstar narrow economic moat rating – or competitive edge – largely because its advantage in the cost of resins, which account for up to 50 per cent of manufacturing costs.

“A small advantage in the cost of resins makes for a meaningful cost advantage,” says Slade.

“We believe that the scale players in the Australian market enjoy 10 to 15 per cent better terms than smaller players, translating to an approximate 5 to 7 per cent advantage is total manufacturing costs and thus improved gross margins relative to non-scale players.”

Slade expects Pact’s revenue to grow at 6.1 per cent in the next five years as resin prices climb over the period, up from a previous 4.2 per cent.


is senior editor for Morningstar Australia

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