A New and Improved Package
We have been positive on the global packaging space, having recommended a number of large players, both in Australia and offshore. This week we are looking further down the league table, and at Pro-Pac Packaging (ASX:PPG) which completed its “transformational” $177.5 million acquisition of Melbourne-based flexible packaging firm Integrated Packaging (IPG) on 6 November 2017.
IPG is described as Australia’s largest specialist manufacturer and distributor of flexibles, blown film, wrap and associated products.
It services both agricultural and industrial markets with a focus on agriculture, horticulture, logistics, industrial and selected FMCG (fast moving consumer goods) sectors. While the shares have done little for many years, the acquisition has enhanced the investment attractiveness of Pro-Pac.
IPG has manufacturing facilities in Melbourne, Sydney, Perth and Auckland with “growing export capacity.”
The prospects for the flexible packaging segment look relatively strong and the market is expected to grow faster than GDP and overall packaging sector. The broader flexible packaging market is pinned at around $2.2 billion and IPGs part of the market at approximately $1.0 billion. Demand growth is estimated at 4% per annum over the next 10 years, underpinned by a shift towards convenience packaging (think pre-prepared vegetables and others at the supermarket), with the move towards unitisation to reduce product wastage and shrink wrap being used a substitute for crates and boxes.
The deal is strategically highly complementary and provides a platform for growth in the attractive flexible packaging market. It also stacks up on the financial side and is expected to be earnings accretive from FY18 on a pro-forma basis. The company identified $2.0 million in cost synergies prior to the transaction that are expected to be “easily achievable,” along with cross-selling opportunities. Finally, with the deal partly funded by an equity raising, the balance sheet does not look overly stretched. IPG combines well with PPG’s strength in distribution and other packaging.
The combined entity can also provide a “complete end-to-end solution.”
Source: Pro-Pac Packaging (ASX:PPG)
There was no material crossover for existing customers of the two companies, with the new PPG having a diversified customer base with no single customer accounting for more than 4% of sales and many blue-chips on the roster.
Source: Pro-Pac Packaging (ASX:PPG)
The transaction consisted of $117.5 million in cash and $60 million in PPG shares payable to the vendors of IPG. The acquisition multiple was a reasonable 7.6x pro-forma forecast FY18 EBITDA of $23.2 million. At the time the deal was inked it was expected to be 18% accretive to earnings per share on a FY18 basis.
1H18 Headline Numbers
Moving onto a brief look at the company’s first set of financial numbers post the Pro-Pac Packaging (PPG) deal and revenue from ordinary activities
of approximately $158 million for the half-year ending 31December 2017 (1H18) represented an increase of 35.8%.
The result included almost two months of trading for IPG. On a standalone basis, PPG revenue of approximately $121 million was up 4.3% from a year earlier.
The company cited “strong” trading conditions in the horticultural, industrial, pharmaceutical and FMCG markets, while red meat and agricultural crops were weaker as unfavourable weather conditions resulted in lower yields for its customers. The bulk (~84%) of business for the new PPG is in the flexible and industrial areas.
Source: Pro-Pac Packaging (ASX:PPG)
The company reported an EBITDA loss of $353 thousand due to a raft of costs associated with the IPG acquisition. Group underlying EBITDA from ordinary activities before relocation, restructuring and business combination costs was $9.55 million, marking a 30% year-on-year increase. The following provides the reconciliation between underlying EBITDA and reported EBITDA, with the major items discontinued and redundant stock lines, surplus leases and exit costs, along with other costs and legal fees.
Source: Pro-Pac Packaging (ASX:PPG)
Management reported that integration synergies are head of target, with phase one consisting of $2.0 million in annualised savings implemented. Phase 2 synergies focused on consolidation and rationalization have been identified with the potential for another $3.0 million in savings per year. Planning was underway at the time of the interim results announcement in February, with early benefits expected to begin flowing through from June 2018.
The company said it is on track to generate an annualised pro-forma sustainable EBITDA, including synergies, of $37.7 million, which is in line with expectations at the time the acquisition was announced.
Source: Pro-Pac Packaging (ASX:PPG)
The company reported a statutory loss after tax of $3.2 million, which includes the $9.9 million of one-off acquisition, rationalisation and relocation costs. Diluted earnings per share fell from 1.43 cents a year earlier to a loss of 0.93 cents. Underlying profit before tax came in at $5.95 million, up 15.8% from a year earlier.
Group operating cash flow increased from $2.98 million a year earlier to $14.5 million in 1H18. Even after the IPG acquisition the gearing ratio (net interest bearing debt / (net interest bearing debts plus shareholders’ equity) was reasonable at 28%. The company is targeting a leverage ratio in the target range of 1.5x – 2.3x in FY19 after a full year contribution from IPG. Net debt increased to $85.1 million at the end of December 2017 from $16.8 million at the end of June 2017.
Looking at the breakdown of underlying EBITDA by segment and the Industrial & Flexibles segment (which includes IPG) had sales of $127 million, up 48.1% year-on-year due to the inclusion of almost two months of trading from IPG. Operating margins felt some pressure and were down due to some agricultural stock production not selling through. Segment EBITDA was $7.2 million, up 27.6%.
Source: Pro-Pac Packaging (ASX:PPG)
Revenues in the Rigid segment edged up 1.2% to $30.9 million, while EBITDA increased 16.8% to $4.4 million as the margin increased to 14.1% by 1.9 percentage points to 14.1% on the back of efficiency improvements.
Summary
We believe the acquisition has enhanced the investment attractiveness of Pro-Pac. The deal is a strong fit strategically and the price tag appears reasonable given IPG’s strong market position. It will provide a platform to expand in the Flexibles packaging market, where there is plenty of scope bolt-on acquisitions to consolidate the industry. PPG has a decent track record with acquisitions having successfully integrated dozens of smaller ones since its listing.
PPG’s current valuation appears reasonable, trading on circa 15.4x forecast FY18 earnings, falling to 12.6x the following year when the IPG acquisition has had a full year of contribution. The projected dividend yield over the same time frame is 4.8%, expanding to 5.3%.
There is however some overhang on the shares, with private equity firm Advent retaining a 15% stake even after the recently announced sale of 59.6 million shares held by the firm to new and existing investors. Advent’s remaining stake will remain in escrow until after the release of the company’s FY19 results.
Accordingly, we Traffic Light Pro-Pac Packaging (ASX:PPG) and will continue to monitor the stock.
