Thursday, May 3rd, 2018
ASX Code: PPG
Security price: $0.39
Forecast FY19 distribution: 2.3 cents per
For the income-focused investor, small companies with low margins and unremarkable products or services are not typically attention-grabbing. Pro-Pac Packaging (PPG), a diversified distribution company providing flexible and rigid plastic packaging solutions, historically fell into such a category. PPG acted as a middleman, offering logistics and storage services for packaging, as well as limited manufacturing capability, sourcing product from third party manufacturers to fill its supply shortfall.
Last September however, PPG announced its intention to merge with IPG, Australia’s largest specialist manufacturer of flexible plastic packaging. IPG has a much larger manufacturing capability than PPG but lacks an extensive distribution capability making it a strong strategic fit. The combined group structure is more vertically integrated, better utilising existing capacity in manufacturing and distribution to service larger and more complex projects. This should help PPG win market share, while also improving asset utilisation and operating leverage which should drive margin improvement over time.
This margin improvement opportunity is not widely understood in the market. Guidance has already been upgraded from $2m originally to $6m by FY18. We believe the entire long-term cost saving opportunity could ultimately be significantly higher given commentary from management and the quantum of synergies (relative to sales) realised historically in similar mergers. Management will however need to integrate multiple systems, optimise the asset base and logistics, and create a cohesive culture and vision. FY19 is likely to be the first year where the combined group can be assessed in full, with stronger growth being driven by synergies and a cyclical upturn in agricultural volumes.
Concurrently, PPG will also benefit from the structural growth in flexible packaging driven by a shift towards convenience packaging, unitisation, and cost savings. Fresh produce that previously sat in large piles in boxes in the supermarket are now being pre-packaged, this standardises the number/weight of the item, reduces losses from perished product and saves the customer time. As a result, flexible plastics demand is forecast to grow well in excess of GDP over the next 10 years.
Following unseasonable weather which depressed grain volumes, and a slight delay to some equipment installation, PPG recently revised its EBITDA guidance down four per cent. The share price fell as a result, and once again presents compelling value on a one to three-year view. On current forecasts, PPG offers a fully franked yield of around five per cent in FY18, and nearly six per cent in FY19 and beyond, paying investors to wait for PPG to emerge as one of Australia’s leading flexibles manufacturer.
Clime Group owns shares in PPG for and on behalf of various mandates for which it acts as investment manager.