Plenty of upside in the Amcor-Orora demerger

Amcor's investment in Orora ahead of last year’s demerger appears to be paying off, providing it with a platform to deliver solid profits as well as easier access to growth capital.

When Amcor’s Ken Mackenzie announce the demerger of the group’s Australasian and North American packaging businesses last year it might have looked like he was keeping all the sexy businesses and hiving off a portfolio of low-growth operations.

Amcor’s recent announcement of a 25 per cent increase in earnings for the 2014 financial year confirmed its reputation as a growth company. Today’s results from the somewhat awkwardly-named Orora, however, were a testimony to the work that was done to prepare the business for the demerger.

Orora’s Nigel Garrard delivered a 44.8 per cent increase in earnings (on a pro forma basis, given that Orora hasn’t operated as a standalone company for a full 12 months) on sales which grew at almost 8 per cent over the year. Operating cash flow grew from $168.9 million to $224.1m.

Amcor had put a lot of effort and capital into Orora ahead of the demerger. It had invested about $1 billion in the business, including $500m in a new recycled paper mill that still has about 18 months to go before it is operating at full capacity. It also took some heavy impairment charges as it prepared the business for its independence.

Instead of being tempted to wait until the full benefit of the transformation program he initiated to flow through, Mackenzie left significant upside for Orora and its shareholders.

Orora was spun off in the early phase of a major and quite structural cost-reduction program targeting the best part of $100m. For the 2012-13 financial year, about $12m of that was achieved. In the year to June, Garrard took out another $39.1m of costs. He has more than $50m of cost-reductions to go, which by itself leaves upside for shareholders.

Sales in Australia were flat, although the Botany recycled paper mill is ramping up, but underlying earnings before interest and tax were up 25.7 per cent to $162.5m and the EBIT margin improved from 6.7 per cent to 8.5 per cent.

In North America, which represents about a third of Orora’s portfolio, sales were up 25.4 per cent to $1.3bn and EBIT was 31.3 per cent higher at $57.1m.

So there is both sales growth and continuing cost-reductions flowing through the group to generate future growth in earnings.

The strong cash flow performance of the business and the fact that Mackenzie didn’t load it up with debt means that it also has a conservative balance sheet.

Gearing was reduced from 35 per cent to 31 per cent, which leaves scope for Orora to both sustain a strong payout ratio of 70 per cent of earnings while also building its portfolio with bolt-on acquisitions.

Orora says it will consider capital management opportunities in the absence of suitable growth investments, which signals a commitment to financial discipline, but its ability to contemplate acquisitions is one of the obvious benefits of being distanced from Amcor.

Within Amcor, the lower-margin packaging operations that ended up in Orora wouldn’t have been able to compete for capital against the range of global growth options Amcor has. Set free, it can make its own decisions on how to allocate cash and capital. It does generate strong and stable cash flows.

Demergers have suddenly become fashionable again. The BHP Billiton proposal to spin off $US15bn or so of assets is the most notable, but the Brambles/Recall demerger is another good example, largely because companies have become more focused on their returns on capital and are rationing their capital and preserving it for the best-returning businesses.

With Amcor, Orora would have struggled to get access to growth capital. As an independent entity it can invest in future growth.

To Amcor’s credit, however, it did invest in the businesses ahead of the demerger -- it didn’t starve them of capital or attention -- and has given it the platform to deliver sold profits underwritten for at least the next couple of years by the continuing reduction in costs. Beyond that it is up to Garrard and his team to continue to deliver top-line growth. They are off to a decent start.