Recycling has a crucial role in the economy
Recycling is an industry of the future. Industries are finding innovative ways to produce new products from waste materials. Adidas says it expects to make 11-million pairs of shoes in 2019 using recycled ocean plastic. This is more than double the number of pairs it made this way in 2018. So far, they have stopped 2,810 tons of plastic reaching our oceans.
According to PET Plastic Recycling Company (Petco), recycling polyethylene terephthalate (PET) bottles created an estimated 68,000 income opportunities in 2018. To date, recycling PET bottles has saved more than 4.3-million cubic metres of landfill.
Glass recycling is pivotal. The Glass Recycling Company says 42% of glass is recycled and about 80% diverted from landfill by recycling. Mpact, an offshoot of Mondi, the largest collector of recyclable packaging and producer of packaging products, has faced significant price pressure, having fallen from highs of R52 in 2016 to about R16 now.
The Western Cape drought, SA’s depressed economic growth and the capex project at the Felixton Mill have been factors. Mpact had up until 2016 performed well in earnings and cash flow. Though the company has fallen on hard times, I have confidence that the share price represents value and that management will be able to get the group back to a more normalised level of earnings.
The results to June illustrated the start of the earnings recovery. Underlying earnings per share grew 25%, driven by a strong recovery in the paper business, with paper earnings before interest and taxes margins increasing to 7.3%, from 5.6% in the prior year. The sustainability of this increase is crucial to the investment case.
Management says the paper margin can rise to above 10%, driven by efficiency improvements at the Felixton Mill and increasing vertical integration with recycling and use of recyclable material. Waste paper is a key market. Mpact will need waste paper prices to remain low to help improve paper margins. Additional catalysts for earnings include a recovery in the plastics business as the Western Cape drought recovery continues, improvement in the plastics polymers business to break even (now unprofitable), as well as the utilisation of tax incentives associated with the polymers business.
From a cash-flow perspective, management guided towards improvement in the full-year working capital position (particularly in inventories), which would go a long way to degear the group from net debt to earnings before interest, tax, depreciation and amortisation of 2.2 times. This could also add an interest-cost saving tailwind to earnings.
GOLD
Gold has traditionally offered portfolio diversification. With the economic stress we are experiencing, it has decoupled from the stock market. Over the past five-, three- and one-year periods gold has outperformed the JSE all-share index in dollar terms on a total return basis.
The gold price is volatile, but unhedged gold shares are riskier and more volatile. This additional volatility is due to the inherent leverage in the mining sector and company idiosyncrasies.
We are in an environment of uncertainty: populism, trade war talk, Brexit, and so on. So there is space in a portfolio for investment in a gold ETF, which offers less volatility and mirrors the gold price and risk hedging properties more appropriately.