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Plastic packers hold up despite 40pc dive in oil price

Glenn Freeman  |  10 Jan 2019Text size  Decrease  Increase  |  
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Refinery petrochemical oil

Plastics manufacturers watch oil prices closely, as the primary feedstock for their product

An oil supply glut has prompted a reduction in Morningstar's near-term oil price forecast, but has failed to dent its positive outlook on plastic packaging companies Amcor and Pact Group.

The recent rout in oil prices has wiped almost 40 per cent off oil benchmarks in the last three months. Brent crude closed at US$58 a barrel on 8 January, down from its recent high of US$86.29 in early October – even as oil futures lifted 2.4 per cent overnight.

For Amcor (ASX: AMC) and Pact (ASX: PGH), some of the largest manufacturers of plastic packaging in Australia and globally, plastic resins – which are petrochemicals – are key to their operations.

Amcor's $15.2 billion business spans 43 countries, and Pact is the largest in Australia and New Zealand, with expanding Asian operations.

"While not perfectly correlated, resin prices tend to move in unison with oil prices, and we are seeing resin futures also track lower as a result of this relationship," says Morningstar equity analyst, Grant Slade.

His short-term forecasts for both Amcor and Pact have been revised downward, but earnings and valuations remain largely unaffected.

He says the fall in resin costs bodes well for both companies in fiscal 2019, with the first quarter of their financial year characterised by a continued surge in oil prices.

"While contract repricing is generally protective of margins, lags in the resetting of contract pricing means that near-term margins can be crimped by sharply appreciating resin prices.

"While revenue has been reduced by between 5 and 7 per cent for both names over the fiscal 2020-2021 period, earnings growth is unaffected," Slade says.

Morningstar has reaffirmed its fair value estimates for both names – $14.60 a share for Amcor and $4.90 for Pact Group. The latter continues to be the preferred of the two, says Slade, who says it trades with a margin of safety at 0.68 times fair value. At midday, Amcor was trading at $13.23; Pact was trading at $3.54.

"In the case of Amcor, we continue to expect a 10-year operating income CAGR of approximately 3.5 per cent.

"Meanwhile, we expect Pact Group’s operating income to grow at a 10-year CAGR of approximately 7 per cent, also unchanged," Slade says.

He also cites the International Monetary Fund's downgrade of its global growth forecasts in his assessment, which were cut to 3.7 per cent in October 2018 – down 0.2 per cent.

"This translates to lower growth in income per capita over the coming the forecast period. But the impact to forecast volumes is immaterial given the defensive nature of plastic packaging demand, which is largely tied to consumption of defensive food, beverage, and household categories.

"Amcor and Pact’s top lines are therefore largely unaffected," Slade says.

The developed markets in which both companies operate will see some blowback – leading Morningstar to reduce volume projections in Western Europe by 0.7 per cent, but American and Australasian volumes are unchanged.

"Volumes in EMs will be more impacted by the global growth downgrade," Slade says. "But with Amcor and Pact deriving approximately 70 per cent and 95 per cent of sales, respectively, from developed markets [these volume declines will] have a negligible effect on our top-line forecasts."

S&P Global Ratings said it had lowered its average oil price forecasts for 2019 by $US10 per barrel to $US55 for Brent and $US50 per barrel for WTI.

Crude prices have been buoyed by supply cuts from the Organisation of the Petroleum Exporting Countries including top exporter Saudi Arabia, and allies including Russia.

Saudi-based Arab Petroleum Investments Corp, which funds petroleum projects, estimated that oil prices are likely to trade at US$60 to US$70 per barrel by mid-2019.

is senior editor for Morningstar Australia

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