Financial Mail - Investors Monthly
Packaging:
Who’s boxing clever?
Investors who chose to back the packaging sector at the start of 2015 have had outcomes ranging from outstanding to disastrous. It all depended on the company they picked.
Had they gone for Nampak, once up there with the bluest of blue chips, they would have watched the outcome in horror, as its share price went on to slump more than 60%.
Mpact would also have given them little reason to rejoice. Though its share price did rise initially during the first nine months of 2015 it later dived, and ended almost 40% down on its January 2015 level.
The packaging company to have backed at the start of 2015 turned out to be Mondi, the global heavyweight with an annual revenue of €7bn. It rewarded its shareholders with a doubling of its share price.
Mondi, which is focused on paper packaging and is dual listed on the London Stock Exchange and JSE, has earned its strong market following by delivering consistent growth. Over its past four financial years, up to December 2017, Mondi delivered EPS growth of 12% a year in the face of what were until recently adverse market conditions.
Dividend performance over the four years was even better, coming in at 15% a year. In its past year Mondi added a special dividend of €100c to the €62c ordinary annual dividend.
Mondi’s success has been built on a clear strategy that has been in place since its unbundling by Anglo American in 2007 — to shift away from commoditised goods and focus on high-end products where it could gain an advantage based on efficiency and innovation.
This strategy has enabled Mondi to lift its return on capital employed from 13.6% in 2012 to 19.7% in 2017.
In the past five financial years alone Mondi has pumped €2.6bn into capex, and €1.4bn€1.6bn more is earmarked to be spent in 2018 and 2019.
“Our assets give us a clear cost advantage and a platform for strong future growth,” Mondi CEO Peter Oswald said at a recent presentation.
Mondi finds itself in a strong position to benefit from what appears, finally, to be a sustainable market revival, particularly in its key European markets. Based on the location of customers, Western Europe accounted for 38% of revenue in Mondi’s past year, Eastern Europe for 22% and Russia for 10%. North America accounted for 11% of group revenue and SA, where Mondi originated, for only 9% of revenue.
Things are going very much Mondi’s way in Europe. The EU’s GDP grew by 2.4% in 2017 — its strongest showing since 2007 — and the European Commission predicts that it will grow by 2.3% in 2018 and 2% in 2019.
Consumer confidence in the EU has also moved ahead strongly of late and in the first five months of 2018 has been at levels not seen since 2007.
The economic revival and stronger demand in Europe has provided Mondi and other sector members with something they have lacked for many years: pricing power.
In its results release for the first quarter of 2018 Mondi noted: “The strong pricing envi-
Mondi’s success has been built on a clear strategy: to shift away from commoditised goods and focus on high-end products
ronment continues in a number of our key product segments.”
It was clearly evident in packaging paper, a segment which in 2017 accounted for a third of Mondi’s revenue and 47% of its €1.02 operating profit. In Mondi’s first 2018 quarter the packaging paper segment’s operating profit came in 21% up year on year.
It helped lift group EPS 15%, well ahead of the total 8% rise recorded in 2017.
The consensus forecast of 17 analysts provided by Mondi is for its EPS to rise by 11.7% for the full year. The highest forecast is for a 17.7% rise.
The consensus puts Mondi on a not-too-demanding forward p:e of 14.2.
While Mondi has been forging ahead, Nampak has since 2015 been battling a series of crises that have played havoc with its profitability.
Some of Nampak’s problems have not been of its own making. Others tell a story of poor capital allocation, not least
the expansion of its glass bottle operation, which turned in a R55m trading loss on revenue of R720m in Nampak’s six months to March.
Nampak’s glass woes began in October 2014, when it commissioned its third glass furnace. Built at a cost of R1.26bn, it proved to be a technical challenge Nampak could not handle. “Skills availability in SA is a major problem,” says André de Ruyter, who has been Nampak CEO since April 2014.
“We also lost the technical support of our German partner [Wiegand-Glas] in 2012.” Nampak bought out Wiegand-Glas’s 50% stake in its glass operation in 2012 for R935m.
Nampak has finally capitulated on glass, a product it had always viewed as a core part of its business — so core that in 2015 it revealed plans to build glass factories in Nigeria, Ethiopia and Angola.
“We have not yet started the sales process of our glass division but have already had nine serious expressions of interest,” says De Ruyter.
But the glass division has been a minor irritation for Nampak compared with the huge disruption caused by the collapse of the oil price in 2015.
It sparked serious foreign exchange shortages in what are by far Nampak’s biggest nonSA markets, Angola and Nigeria. Unable to repatriate funds from the two countries, Nampak was left high and dry. While the situation in Nigeria has largely been resolved, Angola is still imposing draconian foreign exchange rules. And adding to Nampak’s woes is a dire foreign exchange shortage in Zimbabwe.
Nampak does not provide precise figures, but it is clear that Angola is by far its biggest money spinner. Overall, Nampak’s non-SA African operations lifted trading profit 27% in Nampak’s year to September and contributed 64% of trading profit of R2bn. This contribution was up from just 15% in 2011, when Nampak commissioned its Angolan beverage can plant.
Nampak’s problem in getting access to its cash is worsening. Cash tied up in Angola stood at R2.78bn at the end of March, up from R2.19bn in September. Cash in Zimbabwe rose from R654m to R816m. The cash build-up is driven by profits, says De Ruyter.
Nampak is also facing a problem of another type: the end of tax holidays in Nigeria and Angola. Nampak’s tax holiday in Nigeria ended on December 31, with tax in the first year kicking in at twice the normal 30% corporate rate. It is not a complete disaster, however. De Ruyter says Nampak can write off five years of wear-and-tear allowances and currency devaluation losses.
In Angola the tax holiday ends at the end of April 2019, when tax will kick in at the normal 30%. It could mean a big chunk of profits going to Angolan tax authorities.
The market is looking to a substantial recovery in Nampak’s profitability, for which there is certainly huge scope. A dismal 2.5% return on equity and headline EPS (HEPS) which are less than a quarter of their 2013 level reflects this.
But with Nampak, trading on a stratospheric 43 p:e, any recovery appears fully discounted.
For investors looking to back a packaging-sector recovery situation, Mpact, on a more modest 15.4 p:e, would appear to be a sounder bet. Though still facing difficulties, there is a lot of room for recovery from Mpact, which in its two years to December 2017 recorded a drop in HEPS of 55%. It was a major reversal of fortunes for the paper-andplastics packaging group, which in its three years to December 2015 had almost doubled HEPS. The company was unbundled by Mondi in July 2011.
Numerous negative factors were at work in the past two years, including big and ongoing startup losses in a new PET plastics scrap recycling plant.
But the most serious problem, one largely beyond management’s control, was a rapid rise in the price of old container cartons (OCC) scrap, of which Mpact consumes more than 660,000t a year.
OCC is the key source of raw material for Mpact’s container board division, which accounts for about 85% of group trading profit. OCC makes up about half of the group’s total variable costs.
The global OCC market has faced huge uncertainty, created by China’s determination to crack down on the import of contaminated OCC. The market’s first reaction was to send the price of clean OCC soaring.
In late 2017 China’s policy took another turn, when it shifted to the use of import permits favouring large paper industry players.
“It has resulted in the closure of between 400 and 600 smaller paper plants,” says Mpact CEO Bruce Strong.
China’s move has thrown the OCC market into a surplus position. It is a good development for Mpact, which should benefit in the latter part of 2018 and in 2019, says Strong.
But there is another risk in the short term. It comes from the drought in the Western Cape which has devastated fruit crops.
“The sector accounts for a third of our plastics division’s business,” says Strong.
Mpact holds the promise of a strong recovery. But as with Nampak, there are still risks and uncertainties. For the investor wanting packaging exposure with a high degree of certainty, Mondi has to be the standout choice.